financial accounting foundation - u.s. securities and
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FINANCIAL ACCOUNTING FOUNDATION 401 Merritt 7, P.O. Box 5116, Norwalk, CT 06856-5116 І 203-847-0700
FAX: 203-849-9714
March 11, 2009
Ms. Florence E. Harmon, Acting Secretary Securities and Exchange Commission 100 F Street, NE Washington, DC 20549-1090
RE: File number S7-27-08
Dear Ms. Harmon:
This letter responds to the request for comment on the Securities and Exchange Commission’s (SEC) Roadmap for the Potential Use of Financial Statements Prepared In Accordance With International Financial Reporting Standards (IFRS) by U.S. Issuers (the Roadmap). The mission of the Financial Accounting Standards Board (FASB), undertaken with oversight by the Trustees of the Financial Accounting Foundation (FAF), is to establish financial accounting and reporting standards for public, private, and not-for-profit entities (other than governmental entities), through an independent and open process, resulting in financial reports that provide useful information for investors, creditors, and other external decision makers.
The FAF and the FASB have long supported the development of high-quality global accounting standards.1 The demand for those standards is driven by the desire for high-quality, internationally comparable financial information that capital providers find useful for decision making in global capital markets. The FASB’s participation in the evolution of the international accounting system has been guided by the belief that, ideally, the ultimate goal is the worldwide use of a single set of high-quality accounting standards for both domestic and cross-border financial reporting. We continue to support that goal. Since committing to the 2002 Norwalk Agreement2, the FASB and the International Accounting Standards Board (IASB) have been working toward that goal by coordinating their agendas and working jointly to develop common, high-quality standards.
In 2006, the IASB and the FASB issued a Memorandum of Understanding (“MoU”) detailing the scope of their joint work program to improve and promote convergence of their standards as called for by the Norwalk Agreement. The FASB and IASB updated the MoU in September 20083 to outline the critical convergence projects to be completed jointly by the two Boards.
1 Our 1999 publication, International Accounting Standard Setting: A Vision for the Future, FASB 1999, sets forth our view of an ideal global financial reporting system that includes a single set of high-quality accounting standards set by an independent standard setter. We reiterated our views about the ideal financial reporting system in our November 2007 letter to the SEC. The full text of that letter can be found at the following: http://www.fasb.org/FASB _FAF_Response_SEC_Releases_msw.pdf. 2 The 2002 Norwalk Agreement (http://www.fasb.org/news/memorandum.pdf) outlines the first formal agreement between the IASB and the FASB to collaborate on high-quality, compatible standards. 3 (http://www.fasb.org/intl/MOU_09-11-08.pdf).
FINANCIAL ACCOUNTING STANDARDS BOARD y FINANCIAL ACCOUNTING STANDARDS ADVISORY COUNCIL GOVERNMENTAL ACCOUNTING STANDARDS BOARD y GOVERNMENTAL ACCOUNTING STANDARDS ADVISORY COUNCIL
Ms. Florence E. Harmon March 11, 2009 Page Two
We believe that the primary objective of financial reporting is to provide decision-useful information to investors and other capital providers. We also believe that many investors and other users support the goal of a single, high-quality global accounting language as a means of improving the quality and comparability of financial reporting internationally. The current global financial crisis has revealed a weakness in an international system composed of multiple sets of accounting standards—the presence of real or perceived differences between these standards enable the pursuit of accounting arbitrage that, if unchecked, could result in a “race to the bottom” in financial reporting. We are therefore encouraged that many countries around the world also see the benefits of a common financial reporting language. We believe that the U.S. must be an active participant in the international effort to achieve a common global financial reporting language.
In the Roadmap, as in its 2007 Concept Release, the SEC reiterated its long-expressed support for a single set of high-quality global accounting standards that enhances the ability of U.S. investors to compare financial information of U.S. companies with that of non-U.S. companies.4
The SEC set out for public comment in the Roadmap one approach to achieving that goal—the possible adoption of IFRS as issued by the IASB by all U.S. public issuers in the near term.
Decisions about the role that a single set of high-quality global accounting standards plays in investor protection and the efficiency and effectiveness of capital formation and allocation involve complex, multidimensional and perhaps controversial issues that require careful, measured, and comprehensive study and analysis. We believe the Roadmap is an important step in that process, and we commend the SEC for developing and issuing the Roadmap for public comment.
Our response letter to the SEC’s 2007 Concept Release expressed the view that investors would be better served if all U.S. companies used accounting standards promulgated by a single global standard setter as the basis for preparing their financial reports and recommended moving U.S. public companies to an improved version of IFRS. That letter also described several key changes, both within the U.S. and outside the U.S., that we believed were necessary preconditions for the use of IFRS by U.S. public companies.
Since our 2007 response letter to the Concept Release, we have continued to enhance our understanding of the many complex aspects of this important issue. The following have added to that understanding:
• Input from participants at our convergence forum held in June 2008 that brought together the many diverse parties with a stake in U.S. financial reporting;
• Ongoing discussions with established FASB advisory groups such as the Financial Accounting Standards Advisory Council (FASAC), the Investors Technical Advisory Committee (ITAC), the Small Business Advisory Committee (SBAC), the Private Company Financial Reporting Committee (PCFRC) and others about the future of financial reporting in the U.S.; and
4 On April 25, 2003, the SEC issued a Policy Statement, “Reaffirming the Status of the FASB as a Designated Private-Sector Standard Setter,” in which the SEC states its expectation that the FASB will “consider . . . the extent to which international convergence on high quality accounting standards is necessary or appropriate in the public interest and for the protection of investors” (http://www.sec.gov/rules/policy/33-8221.htm).
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• The significant effects of the global financial crisis on capital market participants over the past year, which, in our view, reinforce the importance of developing appropriate global solutions to global problems, including those arising in financial reporting.
In addition, to help us further develop our thinking about the nature and scope of issues involved in a potential use of international financial reporting standards in the U.S., we engaged two independent consultants to provide us with objective analyses of the economic and policy considerations that they felt were most salient to a potential U.S. decision to adopt IFRS.5
Among the major findings of these studies are the following:
• Both IFRS and U.S. generally accepted accounting principles (GAAP) are considered to be of high quality.
• U.S. adoption of IFRS is not likely to have significant macroeconomic effects in the U.S., either positive or negative.
• While it is perceived that IFRS provides financial statement preparers more discretion in application than U.S. GAAP, such additional discretion may not result in major differences in the application of IFRS by U.S. companies because the U.S. institutional framework plays a major role in shaping how companies would apply the discretion.
• Accounting standards in a jurisdiction evolve to meet the jurisdiction’s specific needs, and thus standards designed to suit one jurisdiction may not suit other jurisdictions’ specific needs.
• Accounting standards are just one factor influencing the degree of comparability reflected in companies’ financial reports; other factors such as managers’ reporting incentives, regulatory enforcement, and auditing also significantly affect the comparability of financial reports.
• Large, multinational U.S. firms may realize cost savings from organization-wide use of IFRS, although those savings are limited by the degree to which component entities are required to report under national GAAP and other bases for statutory and tax reporting purposes.
• Adopting IFRS is likely to impose substantial transition costs on U.S. issuers, and smaller firms are likely to disproportionately bear the costs of adoption.
• Given the rapidly changing world, maintaining the status quo (that is, nonadoption or delayed adoption of IFRS in the U.S.) might result in costs for firms and investors.
• Significant political challenges likely would arise in persuading the U.S. Congress to permit the SEC to designate an international body as the standard setter for U.S. companies.
5 The two reports—Luzi Hail, Christian Leuz, and Peter Wysocki (hereafter, “HLW”), “Global Accounting Convergence and the Potential Adoption of IFRS by the United States: An Analysis of Economic and Policy Factors,” and James Bothwell, “Adopting International Financial Reporting Standards for Use in the United States: An Economic and Public Policy Perspective,”—are attached to this letter as Appendix A.
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The valuable insights we received from carefully considering these and other factors have helped us to develop and refine our views and recommendations expressed in this letter on this important and complex policy issue.
Our views and recommendations are expressed in the following main points:
1. We support the Roadmap’s call for a study by the Office of the Chief Accountant on the implications for investors and other market participants of implementing IFRS for U.S. issuers. We believe that such a study is a necessary step in reaching a timely and well-supported conclusion on the most advantageous approach the U.S. should take in moving toward the ultimate goal of a single set of high-quality global accounting standards, and we urge the SEC to complete that study as expeditiously as possible. We recommend that in conducting its study, the SEC should not only consider the implications for investors and other market participants of implementing IFRS for U.S. issuers (as proposed in the Roadmap), but also should fully examine and evaluate the strengths, weaknesses, costs, and benefits of that approach compared with other possible approaches, such as convergence through continuation of the joint standard-setting efforts of the FASB and the IASB over a longer period as advocated by some investors and other parties. We believe the results of such a study will provide the SEC with greater clarity on the best path forward for the U.S. financial reporting system toward the ultimate end goal. We also believe that the SEC’s completion of the study within the 2011 timeframe set forth in the Roadmap will ensure continuation of the momentum achieved to date on the IASB’s and FASB’s convergence efforts.
In conducting such a study, we believe that the following significant issues, which are not all inclusive, should be considered:
• Steps that can and should be taken through continued international cooperation to more fully realize the potential benefits afforded by adopting a single set of high-quality global accounting standards, given the important effects of other factors that impact the quality and the comparability of reporting outcomes, such as differing incentives, enforcement, and auditing practices, which continue to change over time. 6
• The degree of direct and indirect macroeconomic benefits in the near term and over time to the U.S. and to the world economy through U.S. participation in and contribution to a high quality global reporting system.
• Evaluating the impact of particular paths to adoption of or convergence with international standards by the U.S. on fostering or hindering the movement toward a single set of high-quality global accounting standards.
• Identifying the potential costs and complexity of various paths to parties to the U.S. financial reporting system other than public issuers and actions that could be taken to minimize such costs and complexity in transitioning the U.S. to international reporting standards. As noted by the SEC in the Roadmap, a fundamental change in accounting standards used for preparing financial statements included in filings with the SEC, such as would result from the required use of IFRS by U.S. public
6 HLW, section 3.1 (see Appendix A).
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companies, would affect financial reporting for many other parties (such as federal and state regulators and tax authorities), accounting systems and controls, and auditing.7 Moreover, adoption of IFRS by only U.S public companies would create a two-GAAP system (separate accounting standards for public and nonpublic entities) that would create significant cost and complexity for many parties in the financial reporting system (such as for investors, auditors, educators, regulators, and tax authorities).
Our support for further study should not be viewed as a withdrawal of our support for the ultimate goal of worldwide use of a single set of high-quality accounting standards for both domestic and cross-border financial reporting. Rather, we agree with the SEC that there are complex issues beyond accounting standards that warrant additional analysis to ensure that we pursue the most effective path to achieve that goal. We would be pleased to provide our further thoughts and analysis with respect to potential objectives and issues to consider in conducting the study.
2. We recommend that the SEC form a broad-based Advisory Committee, comprising representatives of the many different parties that have a stake, or interest, in the U.S. financial reporting system, to provide one source of valuable input to the study. That group would be charged with identifying, from each of those varying perspectives, the implications of possible changes in the U.S. financial reporting system. Furthermore, should the conclusions of the SEC study be supportive of a fundamental change in the U.S. financial reporting system, this group could be charged with developing and implementing a transition plan or “blueprint” to ensure that any such change be made in a way that minimizes the cost and disruption to investors, companies, and other participants in the financial reporting system.
3. We believe that the Roadmap has appropriately identified the achievement of important milestones as essential to the decision about whether to adopt IFRS and the timing of any such adoption.8 Among the milestones identified is the continued improvement of accounting standards. The FASB and the IASB are working together on projects identified in the MoU that are aimed at improving both sets of standards in critical areas. However, the MoU does not comprehensively address all existing differences between the sets of standards, nor does it address certain areas of practice where IFRS provides limited guidance, such as accounting for investment companies, extractive industries, and insurance contracts.9
Moreover, several aspects of current IFRS might be difficult to apply in the U.S. For example, the IFRS standard on contingent liabilities has been argued to be incompatible with the legal environment in the U.S. because preparers would be compelled to reveal potentially damaging information about their litigation. Areas of accounting such as this represent potential challenges in any path forward that includes U.S. adoption of IFRS in its current form.
7 See pages 37-42 of the Proposing Release. 8 We note that we believe it is important that the SEC identify objective criteria to determine by the date of decision whether adequate progress has been made on each of the milestones. 9 On October 29, 2008, the FASB decided to join the IASB on its insurance contracts project, which would address the need for guidance in IFRS for firms in the insurance industry.
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Accordingly, we believe that, as noted in the Roadmap, if the SEC considers mandating the use of IFRS by U.S. issuers, it should consider whether those accounting standards are high quality, sufficiently comprehensive, and workable for the U.S. environment.
4. With respect to the milestone addressing the accountability and funding of the global standard setter, we believe that realizing the benefits of a possible move to global accounting standards requires a sufficiently robust, sustainable, and independent standard-setting structure. Recent events have demonstrated the significant pressure that can be brought to bear on standard setters and the adverse consequences such pressure can cause, such as suspension of established due process procedures.10 For accounting standards to serve the needs of users, the standard setter’s governance and financial structure must be designed and operated such that the organization has the ability to maintain focus on the needs of investors and to withstand such undue pressure to the maximum extent possible. We acknowledge recent and ongoing efforts by the International Accounting Standards Committee Foundation to strengthen its governance, oversight, and independence by adopting certain changes to its constitution, including the establishment of a Monitoring Group to provide a formal link between the IASB and its Trustees and major capital market regulators. We support the objectives and await the outcomes of those efforts.
Also important to evaluating the global standard setter is whether its structure is appropriately designed to address the needs of all of its constituent jurisdictions. A global standard setter needs to be aware of and appropriately balance the cultural, legal, institutional, and business practices of the various jurisdictions served. For example, there is an expectation in the U.S. financial environment for the standard setter to be focused on the needs of investors and responsive to the needs of issuers and auditors for interpretation of standards and implementation guidance. In circumstances where the needs of particular jurisdictions are insufficiently met, authorities in those jurisdictions may be inclined to create exceptions or “carve-outs” to established standards that undermine efforts to create comparable financial reports.
Both our 2007 letter and the Roadmap note the importance of ongoing efforts to improve the oversight, accountability, and independence of the IASB, as well as its funding mechanism. We believe that those considerations as well as the others outlined above should be at the forefront of any SEC evaluation of the adequacy and appropriateness of the structural design, role, and responsibilities of any private-sector standard setter.
5. With respect to the proposal for limited early use of IFRS in certain circumstances, we continue to believe that the SEC should not permit an option unless and until there is a decision that all U.S. public companies will ultimately be required to adopt IFRS. We believe that permitting choice before that decision would create the potential for a two-
10 See, for example, http://www.iasb.org/News/Press+Releases/IASB+amendments+permit+reclassification+of+ financial+instruments.htm, which describes the IASB’s amendments to IAS 39 and IFRS 7 to allow reclassification of investment securities, and G. Kessler, “Accounting Standards Wilt Under Pressure,” The Washington Post, December 28, 2008, p. A1, which describes certain circumstances with respect to those amendments. The amendments were made under a suspension of the IASB’s normal due process procedures. The article states that Commissioner Charlie McGreevy of the European Commission “. . . was going to force the changes on the IASB by threatening to remove—or carve out—the existing regulation, leaving nothing in its place.” The article describes Sir David Tweedie, chairman of the IASB, as acknowledging that the IASB needs more protection from political manipulation.
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GAAP system for an extended period of time, resulting in unnecessary complexity and additional costs for investors and other capital market participants. Furthermore, the introduction of additional complexity into the U.S. financial reporting system at this time, without clear identification of the benefits, would be contrary to the efforts currently under way by the SEC, the Public Company Accounting Oversight Board, the FASB, and others to reduce complexity in the system.
6. While the Roadmap has helped to stimulate debate about the potential use of IFRS by U.S. issuers, it has also contributed to significant uncertainty for all participants in the U.S. financial reporting system about whether, when, and how U.S. financial reporting might change. For example, the uncertainty about the path forward creates mixed objectives for standard setting: the FASB currently is working to improve existing U.S. standards and address emerging issues on a timely basis within our own system and at the same time we are also actively working with the IASB to reduce the differences between U.S. GAAP and IFRS by jointly developing common high-quality standards in major areas. Maintaining progress along both dimensions is challenging for standard setters but, more importantly, also creates new areas of divergence and increases uncertainty in our financial reporting system about the direction in which we are heading. This uncertainty further underscores our belief that the SEC should commence a thorough and comprehensive study as soon as practicable and complete it as expeditiously as possible.
Once the SEC has completed the study and gained sufficient clarity about the best path forward, any potential decision to require U.S. issuers to adopt IFRS should provide sufficient lead time for an orderly transition for all key elements of the U.S. financial reporting system. We do not believe that the timeframe as proposed in the Roadmap, with only three years between a decision date and the first year of mandated use of IFRS, constitutes adequate lead time for U.S. issuers to change reporting systems and to provide the three years of financial information that would be required in SEC filings to serve investors’ needs.
In summary, while the FAF and the FASB continue to support strongly the ultimate goal of a single set of high-quality global accounting standards as part of a global financial reporting system, in our view, additional study is needed to better identify, understand, and evaluate the strengths, weaknesses, costs, and benefits of possible approaches the U.S. should take in moving toward that goal.
Thus, we reiterate our support for a study that would have as its focus a thorough analysis of the issues identified by the SEC in the Roadmap as well as the issues outlined in this letter. Ideally, the study would establish criteria to use in evaluating alternative paths toward the desired end, consistent with a framework such as is embodied in the recent GAO report on financial regulation.11
11 “Financial Regulation: A Framework for Crafting and Assessing Proposals to Modernize the Outdated U.S. Financial Regulatory System,” GAO, January 21, 2009.
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We note that given the complexity and magnitude of the issues involved, the study may not yield clear answers and that any decision about the path forward will involve tradeoffs. However, the point of the study is to reduce uncertainty as much as possible so as to ensure that the ultimate decision represents an effective path forward to achieving high-quality, internationally comparable financial information that capital providers find useful for decision making in global capital markets.
Finally, in this increasingly interconnected financial world, all investors, regardless of country, benefit from high-quality financial information. Thus, as the SEC thoughtfully considers the issues raised by the Roadmap and by the public debate generated through the comment process, we remain committed to continuing to work closely with the IASB to improve both U.S. GAAP and IFRS and to eliminate differences between them. We believe these joint efforts will improve the quality of the standards and the comparability of financial information globally and will advance the efforts toward a single set of high-quality global accounting standards.
Sincerely,
John J. Brennan Robert H. Herz Chairman, Financial Accounting Foundation Chairman, Financial Accounting Standards Board
Appendix A
As noted in the letter, to help us further develop our thinking about the nature and scope of issues involved in a potential use of international financial reporting standards in the U.S., the FAF and FASB engaged two independent consultants to undertake separate, rigorous, neutral analyses of economic and public policy factors that should be considered in deciding whether the United States should seek to adopt, along with other major world capital markets, a single set of high-quality international accounting standards, and in designating as the standard setter for the United States an independent, private-sector, international body to establish and maintain those high-quality, international standards.
This appendix includes the following two reports:
• Luzi Hail, Christian Leuz, and Peter Wysocki, “Global Accounting Convergence and the Potential Adoption of IFRS by the United States: An Analysis of Economic and Policy Factors,” February 2009.
• James Bothwell, “Adopting International Financial Reporting Standards for Use in the United States: An Economic and Public Policy Perspective.” January 20, 2009.
Global Accounting Convergence and the Potential Adoption of IFRS
by the United States: An Analysis of Economic and Policy Factors *
February 2009
Luzi Hail
The Wharton School University of Pennsylvania
Christian Leuz
The University of Chicago Booth School of Business, NBER, ECGI and FIC
Peter Wysocki
Sloan School of Management Massachusetts Institute of Technology
* We thank Ray Ball, Hans Christensen, Mark Lang, and Hal Scott for useful discussions and comments on this project.
We also thank the Initiative of Global Markets at Chicago Booth and Ashish Shenoy for providing excellent research
assistance.
Table of Contents
1. EXECUTIVE SUMMARY 3
2. CONCEPTUAL UNDERPINNINGS 9
2.1. EFFECTS OF IMPROVED REPORTING AND DISCLOSURE QUALITY .......................................................................9
2.2. EFFECTS OF MORE COMPARABLE REPORTING PRACTICES................................................................................11
2.3. COST-BENEFIT TRADEOFF RELATED TO FIRMS’ REPORTING QUALITY AND COMPARABILITY CHOICES.......13
3. ROLE OF ACCOUNTING STANDARDS FOR HIGH-QUALITY AND COMPARABLE
REPORTING 14
3.1. INCENTIVES AS KEY DETERMINANT OF REPORTING QUALITY AND COMPARABILITY.....................................15
3.2. COMPLEMENTARITIES AMONG THE ELEMENTS OF COUNTRIES’ INSTITUTIONAL FRAMEWORKS ....................17
3.3. EFFECTS OF IFRS ADOPTION ON REPORTING QUALITY AND COMPARABILITY ...............................................19
3.3.1. General Arguments on the Effects of IFRS Adoption ...............................................................................19
3.3.2. Evidence from Voluntary IFRS Adoptions around the World..................................................................22
3.3.3. Evidence from Mandatory IFRS Adoptions around the World................................................................24
4. COSTS AND BENEFITS OF IFRS ADOPTION IN THE U.S. 29
4.1. SPECIFICS OF THE U.S. ECONOMY AND INSTITUTIONAL FRAMEWORK.............................................................29
4.2. CAPITAL-MARKET BENEFITS OF IFRS REPORTING IN THE U.S. .......................................................................32
4.2.1. Does Reporting Quality Increase with IFRS Adoption? ..........................................................................33
4.2.2. Does the Comparability of Reporting Practices Increase with IFRS Adoption? ...................................37
4.3. COSTS OF IFRS ADOPTION AND REPORTING COSTS SAVINGS TO U.S. FIRMS.................................................39
4.3.1. Transition Costs ..........................................................................................................................................39
4.3.2. Recurring Costs ..........................................................................................................................................42
4.3.3. Cost Savings Arising from a Single Global Reporting System ................................................................43
4.4. WHICH FIRMS ARE LIKELY TO HAVE LARGER NET BENEFITS (OR COSTS) FROM IFRS ADOPTION?.............44
4.5. COMPATIBILITY OF IFRS WITH U.S. REGULATORY SYSTEM, LEGAL ENVIRONMENT, AND ECONOMY .........46
4.5.1. Accounting Discretion and the U.S. Litigation System ............................................................................47
4.5.2. Accounting Differences between U.S. GAAP and IFRS ...........................................................................50
4.5.3. IFRS Reporting and U.S. Disclosure Requirements .................................................................................54
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4.5.4. IFRS Reporting and the Link to Taxation .................................................................................................56
4.6. OTHER MACROECONOMIC EFFECTS ...................................................................................................................58
4.6.1. International Competitiveness of U.S. Capital Markets...........................................................................59
4.6.2. Effects on Service Providers ......................................................................................................................61
4.6.3. Effects on Trade Flows and Foreign Direct Investment ..........................................................................62
4.6.4. Education System ........................................................................................................................................64
5. STANDARD SETTING AND POLITICAL RAMIFICATIONS OF IFRS ADOPTION IN
THE U.S. 66
5.1. COMPETITION AMONG STANDARDS AND STANDARD SETTERS ........................................................................66
5.2. POLITICAL RAMIFICATIONS OF IFRS ADOPTION IN THE U.S. ...........................................................................72
6. POSSIBLE FUTURE SCENARIOS FOR U.S. ACCOUNTING STANDARDS 79
6.1. MAINTAIN U.S. GAAP........................................................................................................................................80
6.2. MAINTAIN U.S. GAAP WITH CONTINUED CONVERGENCE BETWEEN IFRS AND U.S. GAAP........................83
6.3. ALLOW CHOICE BETWEEN IFRS AND U.S. GAAP, BUT REQUIRE RECONCILIATION ......................................84
6.4. ALLOW UNRESTRICTED CHOICE BETWEEN IFRS AND U.S. GAAP..................................................................86
6.5. ADOPT “U.S.-SPECIFIC IFRS”.............................................................................................................................88
6.6. SET CONDITIONAL TIMETABLE TO FULLY ADOPT IFRS ...................................................................................91
6.7. CREATE INTERNATIONAL U.S. GAAP (I-GAAP)..............................................................................................92
REFERENCES 95
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1. Executive Summary
This report provides an analysis of economic and policy factors surrounding a possible decision
by the U.S. Securities and Exchange Commission (SEC) to mandate that publicly listed U.S.
companies prepare and file financial reports in accordance with International Financial Reporting
Standards (IFRS). Based on our review of the academic literature in accounting, finance and
economics, we discuss possible economic consequences as well as political ramifications of such a
decision for U.S. firms, investors, other stakeholders, standard setters, legislators and the economy as
a whole. In doing so, this report discusses many issues that the SEC raised with the release of its
proposed “Roadmap” for the potential use of IFRS by U.S. issuers on November 16, 2008.
The key parts of our economic analysis are organized as follows. Section 2 provides the
conceptual underpinnings and delineates, in general terms, benefits and costs of improving the
quality and comparability of firms’ financial reporting and disclosure practices. Section 3 discusses
the role of accounting standards, relative to other factors, for achieving high quality and comparable
financial reporting. Section 4 applies the analysis to the question of IFRS adoption in the U.S. It
highlights the unique institutional features of the U.S. setting, analyzes potential costs and benefits of
IFRS adoption to U.S. firms and investors, and examines macroeconomic consequences of such a
move. Section 5 discusses the economics of the standard setting process and assesses the political
ramifications of IFRS adoption in the U.S. In Section 6, we apply the concepts from our economic
analysis to discuss a set of possible future scenarios for U.S. accounting standards. The example
scenarios should not be viewed as exhaustive, mutually exclusive, or advocating a particular course
of action. Instead, our discussion of the scenarios is intended to highlight the tradeoffs between
various policy choices.
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Overall, our economic analysis yields several key insights, which we summarize below.
However, we stress that this report should be read and evaluated in its entirety.
Summary of Key Insights
What are the potential costs and benefits of high-quality and comparable reporting?
1. Important potential benefits of high-quality and more comparable corporate reporting practices
are greater market liquidity, a lower cost of capital and a better allocation of capital.
2. The net benefits of high-quality and more comparable reporting vary significantly across firms,
industries, markets and countries, and they can be negative.
What role do accounting standards play in achieving high quality and comparable reporting?
3. The importance of accounting standards for the quality of corporate reporting is more limited
than often thought. Other supporting institutions play an important role in determining reporting
outcomes. Academic studies suggest that firms’ reporting incentives and enforcement of
standards are at least as important as accounting standards in influencing reporting practices.
4. A single set of accounting standards by itself does not guarantee the comparability of firms’
reporting practices, neither within a country nor across countries. This applies to any set of
standards (not just IFRS) and it is true even when the enforcement of standards is very high,
indicating that reporting comparability is not only a matter of enforcement. Comparability in
reporting practices is unlikely to occur as long as firms’ reporting incentives differ.
5. The effects of accounting standards cannot be viewed in isolation from other elements of a
country’s institutional infrastructure. In well-functioning economies, the key elements of the
institutional infrastructure fit and reinforce each other. Thus, changing one element of the
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institutional infrastructure (e.g., the accounting standards) can lead to undesirable outcomes for
the economy as a whole, even if the change unambiguously improves the element itself.
6. There is mixed evidence on the capital-market and other effects around IFRS adoption by firms
around the globe. Not all countries and firms see benefits and, more importantly, it is not clear
that the documented effects can be attributed solely or even primarily to the adoption of new
accounting standards per se.
How will switching to IFRS affect U.S. investors and firms individually and in the aggregate?
7. The direct effects of IFRS adoption on the quality of U.S. reporting are likely to be small. U.S.
GAAP constitute a set of high-quality standards, and it is difficult to argue that a move to IFRS
would bring a significant improvement of the standards within the U.S. context.
8. IFRS adoption likely generates comparability benefits for U.S. firms and investors. These
effects arise from the widespread adoption of a single set of accounting standards around the
world, and not because IFRS is per se better or worse than U.S. GAAP. However, the
comparability benefits to U.S. firms and investors will be limited for at least three reasons.
First, the U.S. is a large economy with many firms. Comparability effects are likely to be larger
for smaller economies with fewer firms. Second, firms and countries have incentives to
implement IFRS in ways that fit their particular institutional infrastructure and meet the specific
needs of their stakeholders. Third, U.S. GAAP and IFRS are already fairly close and are
expected to be even closer by the time the U.S. might adopt IFRS.
9. Thus, the capital-market benefits of IFRS adoption are likely to be limited. We expect the main
impact of IFRS adoption to be on firms’ reporting costs (including potential cost savings), on the
U.S. reporting system, and on the supporting infrastructure. In this regard, our report identifies
both transitional as well as recurring costs from a move to IFRS. There may also be benefits
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from evaluating current processes and using the regulatory change to upgrade previous
practices. Moreover, certain U.S. firms, such as U.S. multinationals, likely have (recurring) cost
savings from IFRS adoption because they can use a single reporting system for their operations
around the world. However, despite the widespread acceptance of IFRS for financial reporting
purposes, it is generally not used for statutory reporting and tax purposes. Therefore, the
magnitude of the cost savings to U.S. multinationals depends on the (future) use of IFRS for
statutory reporting around the world and the acceptance of U.S. GAAP in foreign jurisdictions.
10. Based on our analysis, IFRS adoption in the U.S. primarily involves a trade-off between (i) the
short-term costs of transitioning to a new system, (ii) the comparability benefits, which are
relatively modest but accrue over a much longer horizon, and (iii) the recurring cost savings of
reporting, which accrue primarily to U.S. multinational companies. The net effect for a given
company or the U.S. economy as a whole is not obvious, and crucially depends on the time
horizon and the discount factor used in the analysis.
11. As the outside world is changing, simply maintaining the regulatory status quo in the U.S. will
not guarantee economic status quo. Put differently, delayed or non-adoption of IFRS can have
(recurring) costs for firms and investors as well.
Are IFRS compatible with the current reporting and institutional infrastructure in the U.S.?
12. One of the major perceived differences between IFRS and U.S. GAAP is that the former
allegedly provides more discretion (i.e., less specific standards and less implementation
guidance). We highlight that more reporting discretion is not necessarily a problem and that
firms’ reporting incentives, which are shaped by the U.S. institutional framework, play a major
role in how firms would apply the discretion under IFRS.
6
13. U.S. GAAP started out as “principles-based” and evolved into a more detailed set of standards
in response to changes in the U.S. institutional environment (e.g., litigation). IFRS will be
subject to the same forces once adopted in the U.S. These forces will likely influence IFRS
reporting in the U.S. over time and can hinder the international comparability of U.S. reporting
(even after switching to IFRS).
14. There do not appear to be major incompatibilities between IFRS and other elements of the U.S.
reporting environment and institutional framework. However, various U.S. institutions will
have to be adapted to better match with IFRS. This takes time and introduces transition costs.
Are there any other macro effects from switching to IFRS reporting in the U.S.?
15. Given the already strong institutions in the U.S., IFRS adoption is unlikely to have major direct
macroeconomic effects (e.g., on economic growth). However, certain re-distributional effects
across firms and service providers are to be expected. In addition, there could be smaller effects
from comparability on trade flows, portfolio flows and foreign direct investments, including
international mergers and acquisitions. However, these effects hinge critically on the magnitude
of the comparability effects and the future role of IFRS for statutory reporting around the world.
Are there economic and political considerations with respect to the standard setting process?
16. Switching to IFRS would essentially confer monopoly status to the IASB. In general,
monopolies tend to curb innovation, slow down progress, and are prone to political lobbying.
Having a choice between U.S. GAAP and IFRS would help limit those tendencies, but only to
the extent that firms (within a country) can choose between standards. Competition between
regional or national monopolies is less likely to be effective. In addition, changes in the capital
and product markets, and not just regulatory competition, can be an important force for
innovation in accounting standards.
7
17. IFRS adoption has political benefits, signaling a willingness by the U.S. to cooperate
internationally. At the same time, there are political challenges to global standard setting.
Countries have different goals for financial reporting given the differences in their institutional
frameworks, and they will likely influence the IASB towards their respective goals, which could
lead to standards that are less suited for the U.S. environment. Therefore, reforms to the
governance structure of the IASB should be closely followed by the U.S.
Are there ways to address concerns about IFRS adoption in the U.S. and what are their tradeoffs?
18. Maintaining legislative power for the accounting standards in the form of an endorsement
process for IFRS provides a safeguard against future developments in standard setting that are
not in the interest of the U.S. However, national endorsement mechanisms tend to slow down
the process of standard setting, impede changes in standards and could even lead to national or
regional versions of IFRS.
19. The U.S. could add specific disclosure requirements on top of IFRS. Supplemental disclosure
requirements do not (directly) hurt the cross-border comparability of U.S. reporting, allow for a
customization of IFRS to the U.S. environment, and help achieve the desired level of
transparency by U.S. firms and for U.S. investors. Such a disclosure overlay could provide an
opportunity for the U.S. to assert its leadership in the area of capital-market oriented reporting
(while delegating the formal setting of the accounting standards to the IASB).
20. However, these additional disclosures do have costs to firms. They also affect firms’ reporting
incentives and thereby, indirectly, influence reporting practices and reporting quality, which
implies that additional disclosures can have adverse effects on the comparability of U.S.
accounting numbers.
8
2. Conceptual Underpinnings
This section provides the conceptual underpinnings for our report. As the case for IFRS
adoption in the U.S. and in other countries is generally made on the basis of improvements in
reporting quality and comparability across firms and countries, we focus on these two concepts and
their economic consequences. First, we describe how financial reporting and disclosure quality are
linked to important economic outcomes, i.e., market liquidity, firms’ costs of capital and corporate
decision-making. Second, we discuss how better comparability of reporting across firms and
countries can affect these economic outcomes. Third, we emphasize that there are direct and indirect
costs to improving corporate reporting and that these costs need to be traded off against the benefits
of reporting improvements. It is important to note that, in this section, we use the terms “reporting”
and “disclosure” in a very broad sense, encompassing the wealth of corporate information that firms
provide to investors and other outside parties through various channels. Moreover, the terms
“reporting” and “disclosure” refer to firms’ practices, rather than the standards that govern them.
2.1. Effects of Improved Reporting and Disclosure Quality1
Corporate reporting can have many economic consequences and it is impossible to enumerate all
of them. Moreover, not all effects are well understood and supported by evidence. The one that is
probably best supported by theory and evidence is the effect of reporting quality on market liquidity.2
The idea is that information asymmetries among investors introduce adverse selection into securities
markets, i.e., less-informed investors are concerned about trading with better-informed investors. As
a result, less-informed investors lower (increase) the price at which they are willing to buy (sell) a
1 This section draws heavily on Leuz and Wysocki (2008). 2 We note that “reporting quality” is hard to define and a concept with multiple (possibly conflicting) dimensions. We
use it as a placeholder for desirable properties of corporate reporting, in particular the usefulness of corporate
information to outside investors for decision making and contracting.
9
security to protect against the losses from trading with better-informed counterparties. Similarly,
information asymmetry and adverse selection reduce the willingness of uninformed investors to
trade. Both effects reduce the liquidity of securities markets, i.e., the ability of investors to quickly
buy or sell shares at low cost and with little price impact. Corporate disclosure can mitigate the
adverse selection problem and increase market liquidity by leveling the playing field among investors
(Verrecchia, 2001). Empirical studies support this argument and provide evidence that better
disclosures reduce information asymmetry and increase market liquidity (e.g., Welker, 1995; Healy et
al., 1999; Leuz and Verrecchia, 2000; Bushee and Leuz, 2005).
In addition, better reporting and disclosure can affect the cost of capital. First, there is the notion
that investors require a higher return from less liquid securities, which is in essence a liquidity
premium (e.g., Amihud and Mendelson, 1986; Chordia et al., 2000; Easley et al., 2002). Second,
better disclosure can lower investors’ estimation risks, i.e., make it easier for investors to estimate
firms’ future cash flows. This effect can directly reduce the required rate of return of an individual
security as well as the market risk premium of the entire economy (e.g., Easley and O’Hara, 2004;
Lambert et al., 2007 and 2008). Third, better disclosure can improve risk sharing in the economy,
either by making investors aware of certain securities or by making them more willing to hold them,
which again reduces the cost of capital (e.g., Merton, 1987; Diamond and Verrecchia, 1991).
Empirical studies generally support a link between reporting or disclosure quality and firms’ costs of
capital (e.g., Botosan, 1997; Botosan and Plumlee, 2002; Hail, 2002; Francis et al., 2004 and 2005;
Hail and Leuz, 2006; Leuz and Schrand, 2008), although some of the evidence is still debated (e.g.,
Leuz and Wysocki, 2008 Liu and Wysocki, 2007; Core et al., 2008).
It is also conceivable that better reporting improves corporate decision-making, for example the
efficiency of firms’ investment decisions. The idea is that higher quality reporting reduces
information asymmetries that otherwise give rise to frictions in raising external capital. For instance,
10
high-quality reporting facilitates monitoring by outside parties, such as institutional investors and
analysts, which in turn can reduce inefficiencies in managerial decisions (e.g., Bushman and Smith,
2001; Lombardo and Pagano, 2002; Lambert et al., 2007). The evidence on the effects of reporting
quality on corporate decisions is still in its early stages, but there are a number of studies suggesting
that better reporting leads to higher investment efficiency (e.g., Bens and Monahan, 2004; Biddle and
Hilary, 2006; Bushman et al., 2006; Biddle et al., 2008).
Finally, it is important to note that the effects of reporting and disclosure often extend beyond the
firm providing the information (e.g., Dye, 1990; Admati and Pfleiderer, 2000; Leuz and Wysocki,
2008). The disclosure of one firm can be useful to other firms for decision-making purposes but it
can also help reduce agency problems in other firms. For instance, the disclosure of operating
performance and governance arrangements provides useful benchmarks that help outside investors to
evaluate other firms’ managerial efficiency or potential agency conflicts and, in doing so, lower the
costs of monitoring. While the incremental contribution of each firm and its disclosures is likely to
be small, these information transfers could carry substantial benefits for the market or the economy as
a whole. Empirically, the aggregate effects of such information transfers and governance spillovers
are still largely unexplored, but this does not imply that they are less real or irrelevant.
2.2. Effects of More Comparable Reporting Practices
Another important dimension of corporate reporting is its comparability across firms. Making it
easier and less costly for investors and other stakeholders to compare across firms can make
corporate reporting more useful, even if the quality of reporting is held constant. For instance, more
comparable reporting makes it easier to differentiate between less and more profitable firms or low-
risk and high-risk firms, which in turn reduces information asymmetries among investors and lowers
estimation risk. These improvements resulting from greater comparability can also increase market
11
liquidity and reduce firms’ costs of capital (aside from the cost savings for investors). Similarly,
more comparable reporting across firms from different countries facilitates cross-border investment
and the integration of capital markets. Recent evidence supports this notion (e.g., Aggarwal et al.,
2005; Leuz et al., 2008a). Making it easier for foreigners to invest in a country’s firms could again
improve the liquidity of the capital markets and enlarge firms’ investor bases, which in turn improves
risk-sharing and lowers cost of capital (Stulz, 1981; Cooper and Kaplanis, 1986).
In addition, better comparability can also have effects on corporate decisions and, in particular,
gains from trade. More comparable reports allow firms to make better-informed investment choices
due to a better understanding of competing firms, both within a country and across countries.
Moreover, firms that have comparable financial reports can more efficiently contract with suppliers
and customers in other countries. It may also enable them to bid more easily on government
contracts in another country.
Comparability can also be viewed from a network perspective. Increasing the number of firms
with directly comparable financial reports increases the number of two-way communication linkages
in the “financial reporting” network, which enhances the value of the overall network to both
investors and firms (e.g., Meeks and Swann, 2008). As the network perspective emphasizes, one
firm’s adoption of more comparable reporting practices creates externalities on other firms. That is,
other firms may benefit from an individual firm’s reporting choices.3 However, firms themselves
may not consider the aggregate positive externalities that arise from their own reporting choices.
Therefore, this well-known property of externalities could lead to an economy-wide underinvestment
in more comparable financial reports, and provides a rationale for creating a (private or public)
standard setter who will mandate certain reporting provisions to internalize the positive externalities.
The possible costs for a firm arising from greater comparability are discussed in the next subsection.
12
3
Generally speaking, there is less empirical evidence on the effects of reporting comparability
than reporting quality. Most archival studies that speak to comparability effects have been conducted
in the context of firms’ accounting standard choices. We review these studies in Section 3.
2.3. Cost-Benefit Tradeoff Related to Firms’ Reporting Quality and Comparability Choices
It is important to note that, despite the tangible benefits of better and more comparable reporting
and disclosure, there are also direct and indirect costs to improving corporate reporting. The direct
reporting and disclosure costs come in many forms and include the preparation, certification and
dissemination of accounting reports. These costs can be substantial, especially considering the
opportunity costs of those involved in the process. Moreover, these costs are likely to have fixed
components, making certain reports or disclosures particularly burdensome for smaller firms.
Disclosures can also have indirect costs because other parties can use information provided to capital
market participants (e.g., competitors, labor unions, regulators, tax authorities, etc.). For example,
detailed information about line-of-business profitability can reveal proprietary information to
competitors (e.g., Verrecchia, 1983; Feltham et al., 1992; Hayes and Lundholm, 1996; Leuz, 2004;
Berger and Hann, 2007).
In light of these costs and the cost-benefit tradeoffs that firms face, it may not be optimal to
strive for the highest-quality reporting regime. In fact, forcing firms to provide certain disclosures
can have net costs to firms, especially smaller firms (e.g., Bushee and Leuz, 2005; Gomes and
Gorton, 2007; Leuz et al., 2008b). Thus, regulators and standard setters need to carefully weigh the
confluence of costs and benefits to firms, investors, and other parties in the economy. Moreover, it is
important to recognize that the net benefits of high quality and more comparable reporting vary
significantly across firms, industries, markets and countries.
13
3. Role of Accounting Standards for High-Quality and Comparable Reporting
As discussed in Section 2, higher quality and more comparable reporting and disclosure can have
economy-wide benefits and positive externalities. Thus, it makes economic sense for standard setters
and policymakers to assess the current reporting environment within a market or country (including
private incentives and other institutional and regulatory forces) to determine if changes to the
reporting environment could move reporting quality and comparability closer to their socially optimal
levels (net of costs). However, it is important to ask how standard setters and policymakers can
achieve these goals and, in particular, what role the accounting standards play in achieving high-
quality and comparable reporting practices. The evidence discussed in the previous section indicates
that capital markets and investors reward higher transparency and high-quality reporting. However,
this evidence does not pinpoint the quality of the accounting standards as the primary source of these
benefits. To the contrary, the evidence from academic studies suggests a limited role of standards in
shaping reporting practices.
To substantiate this important point, we first draw on relevant empirical work from the
international accounting literature, which highlights the role of reporting incentives and countries’
institutional frameworks in shaping firms’ reporting practices. Second, we draw on the notion of
complementarities to illustrate that changing solely the accounting standards is likely to have limited
effects and, in some cases, can even have undesirable effects. The concept of reporting incentives
and the notion of complementarities form an important basis for our subsequent analyses. Finally,
we review arguments on the suggested effects of IFRS reporting and discuss whether the evidence
from voluntary and mandatory IFRS adoption around the world supports these arguments.
14
3.1. Incentives as Key Determinant of Reporting Quality and Comparability
There are a number of recent studies that challenge the premise that changing the accounting
standards alone can make corporate reporting more informative or more comparable. This literature
highlights the importance of firms’ reporting incentives, rather than accounting standards, as key
drivers of observed reporting quality (e.g., Ball et al., 2000 and 2003; Leuz et al., 2003; Ball and
Shivakumar, 2005; Burgstahler et al., 2006). These studies recognize that accounting standards give
firms substantial reporting discretion because the application of the standards involves considerable
judgment. For example, accounting measurements rely on management’s private information and
involve an assessment of the future, making them subjective representations of management’s
information set.
Firms are given reporting discretion for a good reason (e.g., Watts and Zimmerman, 1986). On
one hand, reporting discretion allows managers to use their private information to produce reports
that more accurately reflect firm performance and are more informative to outside parties. On the
other hand, whether managers use their reporting discretion in this way depends on their reporting
incentives. Managers may also have incentives to obfuscate economic performance, achieve certain
earnings targets, avoid covenant violations, underreport liabilities, or smooth earnings – to name just
a few. Given managers’ information advantage, even vis-à-vis the auditors and enforcement
agencies, it is difficult to constrain such behavior. But the issue is not just a matter of proper
enforcement of the accounting standards. While strict enforcement limits the amount of discretion
that managers have, it does not eliminate it. Even in a hypothetical world with perfect enforcement,
15
observed reporting behavior will differ across firms as long as the accounting standards offer
discretion, and there are differences in reporting incentives across firms (Leuz, 2006).4
In general, firms’ reporting incentives are shaped by many factors, including a country’s legal
institutions (e.g., the rule of law), the strength of the enforcement regime (e.g., auditing), capital
market forces (e.g., the need to raise outside capital), product market competition, a firm’s
compensation, ownership and governance structure and its operating characteristics. While the extent
to which we have evidence differs across factors, recent empirical studies clearly support the
importance of firms’ reporting incentives for observed reporting and disclosure practices (e.g., Ball et
al., 2000; Fan and Wong, 2002; Leuz et al., 2003; Haw et al., 2004; Burgstahler et al., 2006).5
Particularly relevant for the IFRS debate are studies showing that even when firms are subject to the
same accounting standards, reporting practices differ considerably across firms and countries (e.g.,
Ball et al., 2003; Ball and Shivakumar, 2005; Burgstahler et al., 2006; Lang et al., 2006).
Overall, this evidence implies that moving to a single set of accounting standards is not enough
to produce comparability of reporting and disclosure practices, even if these standards are strictly
enforced and implemented. Reporting incentives still vary systematically across firms, industries,
stock exchanges, countries, and political regions. Convergence in financial reporting outcomes is
unlikely unless there is convergence in other factors shaping firms’ reporting incentives (e.g.,
Bradshaw and Miller, 2008; Joos and Wysocki, 2007). More generally, the evidence implies that the
role of accounting standards is much more limited than often thought. They are just one of many
factors shaping actual reporting and disclosure practices.
4 The same argument suggests that there will be differences in observed reporting practices across countries even if
they all use IFRS. 5 The literature on earnings management also supports the notion of reporting incentives. See Healy and Wahlen
(1999) and Dechow and Skinner (2000).
16
3.2. Complementarities among the Elements of Countries’ Institutional Frameworks
Accounting standards are one of many important institutional elements affecting financial
reporting practices in a country.6 In well-functioning economies, these elements are likely to be
complementary to each other. For instance, accounting information plays an important role in
financial contracting (e.g., Watts and Zimmerman 1986). Financial claims and control rights are
often defined in accounting terms: e.g., financial ratios specify when a corporate borrower is in
(technical) default or how much the borrower can pay in dividends. Investors in public equity
markets also use financial statements to monitor their claims, make investment decisions or exercise
their rights at shareholder meetings. Thus, it is reasonable to expect that corporate reporting evolves
in concert with other institutional factors to facilitate, among other things, financial transactions and
contracting. Moreover, standardizing reporting, either by regulation or private standard setting, can
reduce transaction costs compared to negotiating what is to be reported on a contract-by-contract
basis (e.g., Ross, 1979; Ball 2001). Crafting accounting standards for the informational and
contracting needs of key parties in an economy increases these transaction costs savings. The key
parties in the economy are also active participants in the political process which affects mandated
reporting policies and other economic regulations (see also, Section 6). Moreover, accounting
standards likely reflect ownership and financing patterns in a country. Conversely, accounting
standards can influence financial contracting (e.g., leases, performance-based compensation, off-
balance sheet financing). Due to these interdependencies, a well-designed set of accounting
standards and other elements of the institutional infrastructure should be complementary, i.e., fit and
reinforce each other. The notion of complementarities implies that countries with different sets of
A country’s institutions include the public and private human-made organizations and conventions that shape
economic behavior. These institutions include the legal system, banking system, taxation system, regulatory and
enforcement agencies, industry associations, standards bodies, networks of professionals, etc.
17
6
institutional endowments are likely to select different accounting standards and that diversity in
accounting standards is an expected outcome of diversity in countries’ institutional infrastructures.
To illustrate this notion, consider a (stylized) financial system in which firms rely heavily on
public debt or equity markets in raising capital, and corporate ownership is dispersed and largely in
the hands of consumers that invest their savings directly or indirectly via mutual funds in public debt
or equity markets. Thus, investors are at arm’s length from firms and do not have privileged access
to information. In such a system, corporate disclosure is crucial as it enables investors to monitor
their financial claims and exercise their rights. We therefore expect that the reporting system focuses
on outside investors ensuring that they are reasonably well informed and, hence, willing to invest in
the public debt and equity markets.
In contrast, consider another stylized financial system in which firms establish close
relationships with banks and other financial intermediaries, rely heavily on internal financing instead
of raising capital in public equity or debt markets, and in which corporate ownership is concentrated.
In this system, the key parties have privileged access to information through their relationships, and
information asymmetries are resolved primarily via private channels rather than public disclosure
(e.g., Ball et al., 2000). In such a system, the role of accounting is not so much to publicly
disseminate information, but to facilitate relationship-based financing, for instance, by limiting the
claims of outside shareholders to dividends, which protects creditors and promotes internal financing.
The key point is that the two stylized financial systems are likely to have very different reporting
regimes, including the accounting standards (e.g., Leuz and Wüstemann, 2004).
The notion of institutional complementarities has a number of important implications for this
study. First, it implies that changes in the accounting standards cannot be considered in isolation
from other elements of the institutional infrastructure. The existence of complementarities implies
18
that changing one element can make the system (or economy) worse off even when the element itself
improves along a particular quality dimension. Thus, it is not obvious that a country should adopt a
new set of accounting standards even if this set is unambiguously “better” than the existing one.
Institutional fit should be part of the consideration. Another implication is that even if countries
harmonize their accounting standards at a given point in time, it is questionable that this
harmonization is stable over time. The new set of standards will be subject to the same institutional
and market pressures that shaped the old set of standards in the first place. Thus, unless other
institutional factors across countries are converging, countries starting with a common set of
accounting standards are likely to drift apart over time, e.g., due to local adaptation and interpretation
or even the introduction of new standards that are not desirable in all countries.
3.3. Effects of IFRS Adoption on Reporting Quality and Comparability
In this section, we discuss several hypotheses about the effects of IFRS reporting. We then
review the empirical evidence on voluntary and mandatory IFRS adoption in various countries
around the world and discuss the extent to which it supports the hypothesized IFRS effects. In much
of the IFRS debate, the arguments are presented in general terms and not tailored to a particular
country. We therefore revisit these arguments and the evidence in Section 4 and apply them to the
issue of IFRS adoption in the U.S.
3.3.1. General Arguments on the Effects of IFRS Adoption
Most of the arguments in favor of IFRS adoption focus on the effects on capital markets and
investors. One argument is that the adoption of IFRS improves financial reporting to outside
investors. To support this argument, proponents point out that IFRS are more capital-market oriented
19
and, hence, more relevant to investors as well as more comprehensive, especially with respect to
disclosure, than most local GAAP.7 If the switch to IFRS does in fact improve corporate reporting
and disclosure, prior analytical and empirical studies suggest that mandatory IFRS reporting should
be associated with an increase in market liquidity as well as a decline in firms’ costs of capital (see
Section 2.1).8
A related argument is that IFRS reduce the amount of reporting discretion relative to many local
GAAP and, in particular, compel firms towards the bottom of the quality spectrum to improve their
financial reporting. Consistent with this argument, Ewert and Wagenhofer (2005) show that
tightening the accounting standards can reduce the level of earnings management and improve
reporting quality. However, as explained in Section 3.1, reducing the amount of reporting discretion
can also make it harder for managers to convey their private information through the financial
statements. Thus, the effect of changes in discretion on reporting quality is a priori not obvious.9
Another argument suggesting favorable capital-market effects is that IFRS reporting makes it less
costly for investors to compare firms across markets and countries (e.g., Armstrong et al., 2008;
Covrig et al., 2007). As discussed in Section 2.2, greater comparability can make financial reports
more useful to investors and other stakeholders, even if the quality of corporate reporting does not
improve. Moreover, using the same set of accounting standards across firms from different countries
likely improves outsiders’ ability to detect earnings management and accounting manipulations, as it
limits the set of permissible accounting treatments, which in turn should improve firms’ reporting
7 See, e.g., Daske and Gebhardt (2006) for evidence on the perception of disclosure quality. See, e.g., Ding et al.
(2007) and Bae et al. (2008) for evidence that IFRS are more comprehensive than most local GAAP. 8 This argument assumes that firms were previously mandated to report under “lower quality” standards that resulted
in relatively poor reporting and disclosure outcomes. The argument is therefore less applicable to countries like the
U.S. which already have high-quality accounting standards. See Section 4. 9 Note that, for the U.S., the argument often goes the other way round. That is, a switch to IFRS is seen as increasing
accounting discretion relative to U.S. GAAP (see Section 4.5.1). See also SEC (2008).
20
incentives. Thus, if the switch to IFRS does in fact improve the comparability of firms’ reports, it
can improve market liquidity and reduce the cost of capital.
Differences in the accounting standards are also viewed as an impediment to cross-border
investment (e.g., Bradshaw et al., 2004; Aggarwal et al., 2005). Thus, the global movement towards
IFRS reporting may facilitate cross-border investment and the integration of capital markets (e.g.,
Covrig et al., 2007). Although the magnitude of this effect is unclear (e.g., Beneish and Yohn, 2008),
making it easier for foreigners to invest in a country’s firms should again improve the liquidity of the
capital markets and enlarge firms’ investor bases, which in turn improves risk-sharing and lowers the
cost of capital (e.g., Merton, 1987).
However, it is also possible that IFRS adoption has only minor, if any, capital-market effects.
IFRS, like any other set of accounting standards, provide firms with substantial discretion and, hence,
the reporting incentives argument applies. Firms that oppose the switch to IFRS or towards more
transparency are unlikely to make material changes to their reporting policies (e.g., Ball, 2006;
Nobes, 2006; Christensen et al., 2007; Daske et al., 2007). This concern applies not only to
recognition and valuation rules, where firms are known to have substantial discretion, but also to
footnote disclosures, which firms can provide in a more or less informative manner.10 Thus, even if
the standards themselves mandate superior accounting practices and require more disclosures, it is
not clear whether firms implement these requirements in ways that make the reported numbers more
informative. The same argument applies for comparability.
This alternate, incentives-based view suggests that countries’ institutional structures and changes
therein play an important role for the capital-market effects around IFRS adoption. All else equal,
countries with stricter enforcement regimes and institutional structures that provide strong reporting
10 See, e.g., the evidence in Gallery et al. (2008) on disclosure differences around IFRS adoption in Australia.
21
incentives are more likely to exhibit discernable capital-market effects around the introduction of
IFRS reporting, if indeed there are substantial differences between IFRS and the local GAAP.
Stricter enforcement and better reporting incentives imply that firms are less likely to get away with
adopting IFRS merely as a label, i.e., without materially changing their reporting practices (for
related evidence, see Daske et al, 2008).11
3.3.2. Evidence from Voluntary IFRS Adoptions around the World
Empirical studies on the effects of IFRS reporting can be divided into two categories, depending
on whether they analyze voluntary or mandatory adoptions. At present, there are only a few studies
that analyze the effects around the introduction of mandatory IFRS reporting; most studies examine
firms’ voluntary decisions. This and the following section review the evidence in both categories.12
Empirical studies on the economic consequences of voluntary IFRS adoptions generally analyze
direct capital-market effects, such as liquidity or cost of capital, or the effects on various market
participants, such as the impact on analyst forecast properties or on the holdings of institutional
investors. Leuz and Verrecchia (2000) examine German firms that adopt IAS or U.S. GAAP and
find that those firms exhibit lower bid-ask spreads and higher turnover compared with German
GAAP firms. Using implied cost of capital estimates, Cuijpers and Buijink (2005) do not find
significant differences across local GAAP and IFRS firms in the European Union (EU). Daske
(2006) examines voluntary IAS adoption by German firms and finds that they exhibit a higher cost of
equity capital than local GAAP firms. Daske et al. (2007) show that firms with a “serious”
commitment to adopting IFRS experience larger cost of capital and market liquidity benefits
11 Conversely, one could argue that countries with better reporting practices before the introduction of IFRS should experience smaller capital-market effects. This argument, however, rests on the presumption that changing the
accounting standards alone improves firms’ reporting practices and ignores institutional reasons why firms in these
countries have better reporting quality to begin with. 12 See also the surveys by Leuz and Wysocki (2008) and Soderstrom and Sun (2007).
22
compared to firms that simply adopt IFRS as a “label.” Finally, Karamanou and Nishiotis (2005)
show positive short-window abnormal returns around the announcement of IAS adoption.
Focusing on reporting quality, Barth et al. (2008) analyze changes in the properties of reported
earnings around the voluntary adoption of IFRS and present evidence that firms’ reporting quality
increases. Hung and Subramanyam (2007) examine a sample of German firms that adopt IAS
between 1998 and 2002. They compare accounting numbers reported under German GAAP with
those under IAS for the same firm-years, and find that total assets and book values of equity are
significantly higher under IAS. In addition, they document that the IAS adjustments to book value
are generally value relevant, while the adjustments to net income are not.
There are also a few studies on the reaction of market participants to voluntary IFRS adoptions.
Cuijpers and Buijink (2005) find an increase in analyst following around IFRS, but the effect is not
robust to controls for self-selection. Ashbaugh and Pincus (2001) show that analyst forecast errors
are positively related to differences in accounting standards between IFRS and various local GAAP,
and that the accuracy of these forecasts improves after firms adopt IFRS. Covrig et al. (2007)
document that foreign mutual fund ownership is significantly higher for IFRS adopters compared to
local GAAP firms and that the difference in mutual fund holdings increases for firms in poor
information environments and with low visibility, suggesting that IFRS reporting can help firms
attract foreign institutional investment.
In sum, the evidence on voluntary IFRS (or IAS) adoptions is somewhat mixed, but on balance
suggests that voluntary adopters experience positive capital-market effects. However, these results
have to be interpreted carefully. As firms choose whether and when to adopt IFRS, it is difficult to
attribute any observed economic consequences to the accounting standards per se. It is possible, if
not likely, that the effects are attributable at least in part to the factors that gave rise to the IFRS
23
adoption decision in the first place. As a result, the evidence can inform us about the potential costs
and benefits of IFRS for firms with particular characteristics but cannot provide a rationale for a
mandate.
3.3.3. Evidence from Mandatory IFRS Adoptions around the World
Studies on mandatory IFRS reporting either examine the stock market reactions to key events
associated with the EU’s movement towards mandatory IFRS reporting or analyze the effects around
the introduction of mandatory IFRS financial statements in certain countries.13 Studies in the first
group try to infer whether the adoption of IFRS in the EU has net benefits (or costs) to firms from
their stock market reactions to key events that made IFRS reporting more or less likely. The
evidence from these papers is mixed. Comprix et al. (2003) examine abnormal returns of EU firms
on four “core” event dates in 2000 that increased the likelihood of mandatory IFRS reporting. They
find a weakly significant, but negative market reaction to the four event dates. However, firms that
are audited by a Big Five auditor, located in countries that are expected to have greater improvements
in reporting quality due to IFRS adoption, or subject to higher legal enforcement experience
significantly positive returns on some of the event dates. Armstrong et al. (2008) examine the
reactions to 16 events between 2002 and 2005 associated with the adoption of IFRS in the EU. They
find a positive (negative) reaction to events that increase (decrease) the likelihood of IFRS adoption,
suggesting that European investors view the introduction of IFRS as beneficial. They also document
that the reaction is more positive for firms from lower quality information environments, with higher
pre-adoption information asymmetry, and for firms that are domiciled in common law countries. The
latter result could reflect concerns about IFRS implementation in code law countries, while the
13 There are also studies that compare the quality and economic outcomes of IAS/IFRS reporting with those of U.S.
GAAP reporting in particular market settings. We review these studies in Section 4.
24
former associations are consistent with investors expecting informational benefits from IFRS
adoption. Christensen et al. (2007) analyze the market reactions of U.K. firms to announcements of
mandatory IFRS reporting in the EU and find that the average U.K. market reaction is small, but that
there is substantial heterogeneity in how markets react. Using the degree of similarity with German
voluntary IFRS or U.S. GAAP adopters as a proxy for U.K. firms’ willingness to adopt IFRS, they
find that this proxy is positively (negatively) related to the stock price reaction around news events
increasing (decreasing) the likelihood of mandatory IFRS reporting. This result is consistent with the
notion that firms’ reporting incentives are central to interpret observed effects around IFRS adoption
(see also Daske et al., 2007).
Studies in the second group analyze the effects of mandated IFRS using data from the first few
annual reports released under the new regime. Platikanova (2007) analyzes measures of liquidity and
information asymmetry in four European countries. She finds heterogeneous liquidity changes for
these countries, but shows that the liquidity differences across countries become smaller after the
adoption of IFRS, which is consistent with comparability effects. Christensen et al. (2008) analyze
whether reconciliations between IFRS and U.K. GAAP around the IFRS introduction convey new
information to the markets, and find that market reactions are concentrated among early announcers
and among companies for which covenant breaches are expected to be more costly. They interpret
their findings as suggesting that mandatory IFRS adoption can lead to wealth transfers between
shareholders and lenders due to changes in the likelihood of breaching covenants. Capkun et al.
(2008) find that earnings reconciliations of EU firms in the transition year are value relevant. As
with all value relevance studies, we do not know whether this result reflects that IFRS reconciliations
provide new information to the markets or that they simply contain information which is also
contained in prices. Horton et al. (2008) and Wang et al. (2008) examine firms’ information
environment surrounding the mandatory introduction of IFRS and find that analyst forecast properties
25
like forecast accuracy, analyst following and forecast dispersion, as well as the relative information
content of earnings announcements, improve after the mandatory adoption of IFRS. However, the
documented effects vary substantially by firms, industries and countries. Daske et al. (2008) examine
the capital-market effects around the mandatory introduction of IFRS reporting in 26 countries using
a variety of proxies. They find an increase in market liquidity after mandatory IFRS reporting
between 3% and 6% relative to the level of market liquidity prior to IFRS adoption. They also show
a decrease in firms’ costs of capital and a corresponding increase in equity valuations (measured as
Tobin’s q), but only when accounting for the possibility that these effects occur prior to the official
IFRS adoption date. Finally, the study indicates that these market benefits exist only in countries
with strict enforcement regimes and in institutional environments that provide strong reporting
incentives. Li (2008) confirms this finding for EU firms using an additional year of cost of capital
data. Alves et al. (2008) provide evidence from short-term liquidity effects around earnings
announcements, suggesting that IFRS earnings by EU firms are viewed as more informative than
prior local GAAP earnings.
In interpreting the results of Daske et al. (2008), it is important to note that the aforementioned
capital-market effects for mandatory (or forced) adopters are relative to local GAAP benchmark firms
that are not required to adopt IFRS or have not yet switched. Firms that have already switched to
IFRS voluntarily prior to the mandate are an alternative group against which one could benchmark
the effects. Daske et al. (2008) document capital-market benefits for (early and late) voluntary
adopters in the year of the mandated switch to IFRS. The magnitude of these benefits often exceeds
the corresponding effects for mandatory adopters, indicating that, relative to voluntary adopters,
mandatory adopters do not gain in market liquidity or market value around the IFRS mandate. As the
latter group already reports under IFRS, one explanation for this result is that mandatory adopters
confer positive externalities on voluntary adopters by increasing the set of comparable firms, which
26
in turn could lead to improved risk-sharing across a larger set of investors. Daske et al. (2008) test
this explanation but obtain insignificant results, possibly due to low statistical power. Another
explanation for capital-market effects of voluntary adopters around the IFRS mandate are concurrent
changes in the institutional environment, e.g., with respect to enforcement, governance or auditing,
which apply to all firms in the economy. As voluntary adopters likely have better reporting
incentives to begin with, they are expected to be more responsive to such institutional changes, which
could explain why they exhibit larger effects than mandatory adopters. This explanation questions
whether the capital-market effects for mandatory adopters can be attributed solely or even primarily
to the adoption of new accounting standards (or the changes in other institutional factors).
At present, there is no direct evidence that concurrent changes in the institutional environment are
responsible for observed capital market outcomes. However, Daske et al. (2008) show that capital-
market effects around the introduction of mandatory IFRS reporting are not evenly distributed across
countries. First, in countries with weak legal regimes and reporting incentives, market liquidity and
firm value remain largely unchanged around the IFRS mandate. Second, the effects around
mandatory adoption are most pronounced for countries with both large local GAAP/IFRS differences
and strong enforcement (or strong reporting incentives). This evidence suggests that the strength of
countries’ enforcement regimes and firms’ reporting incentives play a major role for the documented
capital-market effects, which is consistent with the arguments in Section 3.1. Viewed more broadly,
the evidence is also in line with the notion of complementarities (see Section 3.2) in that the effects
of IFRS adoption depend on other elements in countries’ institutional infrastructure. Consistent with
this notion, recent studies by the Big Four audit firms examining the implementation and compliance
of IFRS in the first year under the new mandate conclude that, despite substantial convergence, IFRS
financial statements retain a strong national identity (e.g., KPMG, 2006; Ernst & Young, 2007a).
27
In sum, there is some evidence of positive capital-market outcomes around the IFRS mandate in
several countries. However, there is considerable heterogeneity in the effects across firms and
countries. Moreover, as with the evidence from voluntary adoptions, it is not clear to what extent the
documented effects can be attributed to IFRS, i.e., changes in the accounting standards per se.
28
4. Costs and Benefits of IFRS Adoption in the U.S.
In this section, we apply the economic framework presented in Sections 2 and 3 to evaluate the
potential adoption of IFRS in the U.S. We start by recognizing that the U.S. economy and
institutional framework are unique in several respects. Thus, even if switching to IFRS has been
beneficial for some countries, it is not obvious that the same would be true for the U.S. We then ask
whether the switch from U.S. GAAP to IFRS changes the quality or comparability of U.S. corporate
reporting practices to gauge the potential capital-market effects from IFRS adoption in the U.S.
Next, we assess the compatibility of IFRS with key elements of the U.S. institutional framework
(e.g., the litigation system, taxation, etc.), and discuss the relevance of existing IFRS/U.S. GAAP
accounting differences. Finally, we discuss various other macroeconomic effects, including the
potential impact on the competitiveness of U.S. capital markets, service providers, trade flows and
foreign direct investments.
4.1. Specifics of the U.S. Economy and Institutional Framework
The U.S. economy and institutional framework are unique in several important respects. First,
the U.S. is by far the largest economy of the world and the size of its public equity markets exceeds
those of all other countries. Based on data for the year 2007 from World Bank, the U.S. gross
domestic product, market capitalization of listed companies, and total value of stocks traded are more
than double the amounts for the next largest individual country. Having large and active stock
markets likely affects firms’ capital structure (e.g., Demirgüç-Kunt and Maksimovic, 1999) and the
choice between public and private financing (e.g., Rajan and Zingales, 1995). U.S. firms typically
rely heavily on publicly traded external finance, which is provided in arm’s length transactions (e.g.,
La Porta et al., 1998). In response, U.S. firms face intense scrutiny by the capital market and its
intermediaries (e.g., financial analysts, institutional investors, and the media). The market forces
29
likely create a strong demand for transparent reporting (e.g., Ball et al., 2000; Bushman et al., 2004;
Burgstahler et al., 2006).
Consistent with the important role of organized capital markets in the U.S., a much larger
fraction of U.S. households, either directly or indirectly through mutual funds, hold debt and equity
securities compared to households in most other countries. These holdings by U.S. households
represent a large fraction of their retirement savings. To support this financial system, there is a
heavy emphasis on outside investor protection in securities regulation and also in the accounting
standards (e.g., Securities Act of 1933; FASB Concepts Statement No. 1). As such, we can view
current securities laws and U.S. GAAP as being primarily (but not exclusively) geared towards
facilitating arm’s length financing and supporting public debt and equity markets. In fact, these laws,
regulations and institutions are considered major factors for the development of U.S. capital markets
and the success of the U.S. economy (e.g., La Porta et al, 1998 and 2000). Moreover, in spite of a
wave of U.S. accounting scandals, the bulk of the evidence in the international accounting literature
suggests that the U.S. reporting system, in conjunction with other U.S. institutions, has led to high-
quality financial reporting that meets the needs of outside stakeholders (e.g., Lang, 2003). Given this
evidence and the role of capital markets for the U.S. economy, the potential capital-market effects of
IFRS adoption, including the impact on investors, should receive special attention.
Second, the U.S. economy and its capital markets are diverse and one cannot treat all publicly
traded firms as a homogenous group.14 For instance, there are several thousand micro-cap firms in
the over-the-counter markets such as the OTC Bulletin Board or the Pink Sheets that have to file U.S.
14 For instance, the majority of U.S. listed firms are relatively small and domestically oriented. Out of the nearly 7,000
U.S. public firms with data available in Worldscope for the year 2005, more than 50% have total assets below $200 million, and only about 25% report generating sales outside the U.S. The variation in size (measured as total assets)
and degree of internationalization (measured as proportion of firms with foreign sales) for the U.S. sample is similar
to the size variation and internationalization of the much larger worldwide sample comprising 22,000 non-U.S.
public firms across many countries, illustrating the heterogeneity of U.S. public firms.
30
GAAP financial statements with the SEC (e.g., Bushee and Leuz, 2005). These firms provide
financial statements that are quite different from those of large-cap multinationals. More broadly, the
reporting incentives view delineated in Section 3 suggests that firms from different industries, trading
venues, and with different ownership and financing structures are likely to exhibit substantial
heterogeneity in their reporting practices, despite the fact that they all report under U.S. GAAP.
Thus, U.S. investors are accustomed to considerable reporting differences at home. In addition, in
2007, the SEC dropped the reconciliation requirement for foreign firms that are cross-listed on U.S.
exchanges and report under IFRS, effectively allowing two different accounting standards for
publicly traded firms in the U.S. Moreover, U.S. investors have extensive portfolio investments
abroad, suggesting that U.S. investors are able to deal with different reporting regimes.
Third, reporting outcomes under U.S. GAAP are generally considered of high quality, e.g.,
reflecting economic events in a timely manner, in particular when it comes to bad news events (Ball
et al., 2000; Hung, 2001), and producing numbers that are transparent and less susceptible to earnings
management (Lang et al., 2003; Leuz et al., 2003). Hence, the properties of U.S. accounting numbers
are often used as a benchmark for other countries’ accounting practices (e.g., Alford et al., 1993; Ali
and Hwang, 2000). However, it is important to note that these results and the quality of U.S.
reporting not only reflect the accounting standards but also other elements of the institutional
framework that influence firms’ reporting incentives. This is the key message from Section 3.
Fourth, the intensity of public enforcement efforts in the U.S. is unparalleled in the world, not
just in terms of rules and regulation (La Porta et al., 2006), regulators’ staffing levels and budgets
(Jackson and Roe, 2008), but even more so in terms of actual enforcement actions and sanctions
imposed (Coffee, 2007). The public enforcement system is complemented by strong private
enforcement, threatening litigation and potentially substantial monetary penalties for managers,
directors, and corporations that engage in reporting misdeeds. These pressures are important when
31
considering the reporting incentives of U.S. firms and the adoption of IFRS, which in contrast to U.S.
GAAP have not evolved under similar forces.
Finally, the ultimate authority to set accounting rules and reporting requirements rests with the
U.S. Congress, the SEC and, as is typical for a common law regime, the rulings set out by the courts.
These legislative bodies have a longstanding tradition of intervening with financial reporting, most
prominently in times of crisis (e.g., Zeff, 2003a, 2003b; Ball, 2008). Thus, the setting of accounting
standards in the U.S. is not limited to one authoritative body (e.g., the FASB), but influenced by
various bodies.
In sum, there are several U.S. idiosyncrasies that must be kept in mind when assessing the
economic consequences of IFRS adoption, notably strong capital markets, already high reporting
quality, effective public enforcement and a strong threat of private litigation.
4.2. Capital-Market Benefits of IFRS Reporting in the U.S.
Based on the arguments and evidence in Section 2, the capital-market effects of IFRS adoption in
the U.S. depend crucially on whether the quality or the comparability of U.S. firms’ reporting
practices change following the switch to IFRS. We therefore discuss whether such changes in
reporting quality or comparability are likely to occur and which direction they might take, applying
the reporting incentives framework developed in Section 3.1 and drawing on recent empirical
evidence, including studies that we have already reviewed in Sections 3.2 and 3.3.
32
4.2.1. Does Reporting Quality Increase with IFRS Adoption?
Much of the debate about whether the adoption of IFRS in the U.S. would change reporting
outcomes focuses on the standards themselves.15 One view is that IFRS are now of a similar quality
compared with U.S. GAAP and that the remaining differences are small. Both sets of accounting
standards have essentially the same underlying philosophy, a capital-market orientation, and roots
based in an Anglo-Saxon common law tradition. In studies comparing the recognition, measurement
and disclosure rules between IFRS and various local GAAP, the U.S. belongs to the group of
countries with the fewest local GAAP-to-IFRS differences (Ding et al., 2007; Bae et al., 2008).16
Moreover, the IASB and the FASB have engaged in numerous convergence activities actively trying
to reduce the differences between IFRS and U.S. GAAP. In 2002, the two standard setting bodies
issued a Memorandum of Understanding (“Norwalk Agreement”) agreeing to make the two financial
reporting standards more compatible and to coordinate their future work programs in order to
maintain compatibility. Since then, IFRS and U.S. GAAP have converged in a number of areas,
bringing the two sets of standards even closer together. In addition, proponents argue that IFRS are
more principles-based and cheaper to implement than U.S. GAAP, which are often perceived as
being too detailed and complex (e.g., PwC, 2007). The arguments outlined above suggest that U.S.
adoption of IFRS is likely to yield similar reporting practices and reporting quality to U.S. GAAP,
and might even offer long-run cost savings to firms.
An alternative view is that the adoption of IFRS would imply major reporting changes and likely
lead to lower reporting quality in the U.S. This view is based on arguments that many important
15 See, e.g., Deloitte, 2007; Ernst & Young, 2007a, 2007b; PwC, 2007; KPMG, 2008b. 16 Both studies rely on data for the year 2001, and therefore do not take into account the ongoing convergence initiative
between the IASB and the FASB. In an earlier study, Harris and Muller (1999) reach a similar conclusion by
showing that reconciliation amounts from IAS earnings and book values to U.S. GAAP numbers prepared by a
sample of cross-listed firms in their Form 20-F filings are smaller than the reconciliation amounts from various other
countries’ national GAAP to U.S. GAAP.
33
differences between the two standards remain (e.g., Benston et al., 2006); that IFRS offer more
discretion and less guidance and, hence, more room for earnings management; and that they are less
tested and comprehensive than U.S. GAAP.17
Based on arguments alone, it is difficult to decide which of the two viewpoints has the upper
hand. Moreover, based on the economic framework presented in Section 3, a simple debate over the
“which standards are best” is likely to miss other more important factors that influence the quality
and comparability of firms’ reporting practices. Standards are only one of many factors determining
reporting outcomes, and even if IFRS were an unambiguous improvement, it does not immediately
follow that IFRS adoption is beneficial in the U.S., as the issue of institutional compatibility needs to
be considered (see Sections 3.1 and 3.2). Thus, in our view, a sole focus on accounting standards is
not appropriate and the standards debate is misguided.
Our economic framework, drawing heavily on the reporting incentives view, suggests that the
U.S. adoption of IFRS is unlikely to have a major impact on reporting quality. To the extent that
U.S. firms currently optimize their reporting strategies, they are expected to resist mandated changes
that are not in their interest by using the flexibility inherent in the standards. The reporting incentives
that were at play in the U.S. before the introduction of IFRS will still be at play after the switch. For
this reason, IFRS adoption alone is unlikely to increase reporting quality and yield substantial capital-
market benefits, even when IFRS are viewed as superior to U.S. GAAP (e.g., Ball, 2006; Christensen
et al., 2007; Daske et al., 2007, 2008). Conversely, it is difficult to force firms to reduce their
reporting quality below its optimal level. Firms can always go beyond the required disclosures and
provide further explanations or reconciliations in the notes. Thus, IFRS adoption in the U.S. is
unlikely to decrease reporting quality, unless we believe that U.S. GAAP and the SEC disclosure
17 See also the views summarized in the Roadmap (SEC, 2008) and, for example, the article by Marie Leone,
“Regulator Rips Into Global Accounting Plan” in CFO.com (September 10, 2008).
34
regime significantly exceed the optimal level of reporting quality from a firm’s perspective. If the
current level of reporting quality is close to what investors demand and firms must provide to support
outside financing needs and existing ownership structures, firms will continue to face a strong
demand for transparency and public information after the switch to IFRS. In addition, the relatively
strong U.S. enforcement mechanisms will remain in force.
For the same reasons, more discretion in IFRS combined with less guidance is not necessarily
bad. While it is possible that firms use discretion to manipulate earnings (or to “reset” their balance
sheets when transitioning to IFRS), more discretion also allows managers to convey a firm’s
economic performance to outsiders in a better or less costly way.18 Less guidance and fewer bright-
line rules could imply that there is less transaction structuring to obtain a specific accounting
treatment (e.g., off-balance accounting for leases or special purpose vehicles). Again, how firms use
the discretion largely depends on managers’ reporting incentives and, unless these incentives changes
major changes in reporting quality are unlikely. Moreover, the U.S. has aimed to shore up
enforcement in the wake of recent corporate scandals. For instance, the passage of the Sarbanes-
Oxley Act in 2002 has tightened firms’ internal controls, which should positively affect managers’
reporting incentives when facing more discretion.
Consistent with the above prediction that the switch to IFRS is unlikely to have a major impact
on reporting quality, there are empirical studies that specifically compare the reporting outcomes
under IFRS and U.S. GAAP. First, several studies analyze the properties of reported accounting
numbers in settings where firms could choose between IFRS and U.S. GAAP for financial reporting
18 The results in Subramanyam (1996), for example, suggest that the majority of U.S. firms use discretion in a way to
make earnings more informative and not for earnings management purposes. See also discussion in SEC (2008).
35
purposes. 19 They find that earnings and book values differ little in terms of value relevance,
timeliness or earnings management (Bartov et al., 2005; Van der Meulen et al., 2007).
Correspondingly, there is little evidence that markets or investors view the outcomes differently, as
evidenced by similar market liquidity and information asymmetry across IFRS and U.S. GAAP firms
in settings where other institutions (e.g., enforcement) are held constant (Leuz and Verrecchia, 2000;
Leuz, 2003).
A second set of studies investigates foreign firms that are exchange-listed in the U.S., prepare
financial statements in accordance with IFRS, must provide reconciliations to U.S. GAAP, and are
subject to SEC oversight (e.g., Pownall and Schipper, 1999). The empirical findings are mixed.
Using various measures of earnings quality and value relevance, there is no clear evidence that U.S.
GAAP or IFRS numbers dominate, and in many cases the earnings properties across the two
standards are indistinguishable (e.g., Harris and Muller, 1999; Barth et al., 2006; Gordon et al.,
2008). At the same time, reconciled U.S. GAAP numbers from Form 20-F filings seem to be subject
to more earnings management, exhibit lower associations with share prices and are less timely to
recognize losses than numbers prepared by U.S. firms (Lang et al., 2006). However, this result likely
reflects the influence of cross-listed firms’ home-country reporting incentives and institutions, or
incentives stemming from the act of reconciliation itself (Leuz, 2006). Similarly, Barth et al. (2006)
directly compare IFRS and U.S. GAAP earnings across a matched sample of non-U.S. and U.S.
firms, and find evidence that IFRS numbers are of lower quality. Again, it is not clear that this
evidence should be interpreted as suggesting that IFRS leads to lower quality financial numbers
because firms outside the U.S. are generally subject to different reporting incentives and, hence, we
would not expect them to exhibit the same properties as U.S. firms, even under the same set of
19 Examples of such settings were German exchange-listed firms after the 1998 enactment of the KapAEG law, former
New Market firms in Germany, or exchange-listed firms in Switzerland after the 1991 revision of the company law.
36
standards. Consistent with this view, Lang et al. (2003) show that firms’ local GAAP reporting
improves around U.S. cross-listings, likely reflecting a change in reporting incentives when firms
become exposed to the U.S. institutional environment.
In sum, given the quality of U.S. GAAP combined with strong enforcement and market-based
incentives already in place, IFRS adoption is unlikely to improve reporting quality in the U.S. any
further. Thus, it would be difficult to justify the move to IFRS only on the basis of reporting quality
effects and the associated capital-market benefits delineated in Section 2.1. Moreover, there are
likely limits to how much market liquidity and costs of capital can improve as a result of reporting
quality increases. Such constraints are more binding for countries like the U.S. where reporting
quality is already high. At the same time, it is also unlikely that reporting quality substantially
declines.
4.2.2. Does the Comparability of Reporting Practices Increase with IFRS Adoption?
While we expect IFRS adoption to have relatively small effects on reporting quality, it is more
likely to have an impact on the cross-border comparability of U.S. reports, especially now that many
other countries have moved to IFRS reporting. As explained in Section 2.2, if IFRS adoption makes
financial reporting by U.S. firms more comparable to the reports of foreign firms, a number of
positive capital-market effects are likely to ensue. These comparability benefits could provide a
rationale for switching to IFRS.
However, there are several factors that limit the magnitude of the comparability benefits from
IFRS adoption in the U.S. First, the reporting incentives view and the discretion argument apply
equally, if not more, to reporting comparability. Consistent with this view, evidence from the
adoption of IFRS in other countries suggests a tendency of firms to refer to their previous, local
GAAP when making judgment calls and exercising discretion under IFRS (e.g., KPMG, 2006;
37
ICAEW, 2007; Christensen and Nikolaev, 2008). We expect U.S. firms to do the same. Thus, as
discussed in detail in Section 3, IFRS adoption around the globe is unlikely to achieve true
comparability in reporting practices. However, using a common set of accounting standards could
make reporting more comparable in the sense that it narrows the set of permissible accounting
treatments. As such, IFRS adoption can lead to some improvements in comparability, including
associated cost savings for investors.
Second, the magnitude of the comparability benefits is presumably a function of the closeness of
local GAAP to IFRS (e.g., Bae et al., 2008; Daske et al., 2008). If true, the benefits in the case of the
U.S. are likely to be modest, since IFRS already closely resemble U.S. GAAP in many areas. More
importantly, this implies that many comparability improvements for U.S. firms should have already
been realized when the bulk of countries with large accounting differences between prior local GAAP
and either IFRS or U.S. GAAP switched to IFRS in recent years. In essence, the switch of other
countries to IFRS should have conferred positive externalities on U.S. firms.
Third, taking a network perspective, one could argue that the comparability benefits are largest
for smaller countries that have idiosyncratic accounting standards and opt into a large network with a
common set of accounting standards (e.g., Meeks and Swann, 2008). As the U.S. capital markets are
large and offer many U.S. peers using the same set of accounting standards (i.e., U.S. GAAP), it can
be argued that the comparability benefits for U.S. firms from joining the “IFRS network” would be
relatively small. On the other hand, given that the global “IFRS network” has now achieved a
significant scale, the benefits for U.S. firms to joining such an established network will be larger
compared to joining the underdeveloped IFRS network of the 1990s. At this point, however, there is
little direct evidence on the comparability benefits from IFRS reporting that would allow us to gauge
the magnitude of the effects.
38
Taken together, we conclude that a positive impact from IFRS adoption likely arises from
comparability and network effects. There are several factors that limit the magnitude of these
benefits for U.S. firms and investors. But even if the benefits turn out to be modest, it should be
noted that they are recurring in nature and, hence, accrue over the long-run.20
4.3. Costs of IFRS Adoption and Reporting Costs Savings to U.S. Firms
It follows from our previous discussions that the capital-market benefits of IFRS adoption and
the effects on U.S. reporting practices are likely to be limited. Nonetheless, there could be a
significant impact on the reporting infrastructure and firms’ reporting processes and systems. We
therefore shift our focus to the cost consequences. The largest out-of-pocket costs will likely occur
during the transition phase, and not on an ongoing basis. In the long run, costs could arise indirectly
from necessary changes in the institutional environment as a consequence of the switch to IFRS.
Furthermore, there can be cost savings to firms that operate in multiple countries and adopt IFRS for
all their operations.
4.3.1. Transition Costs
Many of the issues related to IFRS adoption are transitional in nature leading to one-time or
short-term costs. Firms will have to adjust their accounting systems and processes and, as required
under the Sarbanes-Oxley Act (SOX), update the documentation of internal control procedures. In
the first year of publishing IFRS reports, they will also have to provide at least one year of
comparative prior period financial information (IFRS 1), maybe even up to three years under existing
SEC regulation. In addition, firms will need to train their employees in the preparation of IFRS
financial statements as well as familiarize outside stakeholders like analysts and investors with IFRS
20 Moreover, some of the benefits occur at the level of the individual investor and hence need to be aggregated across
investors, which could result in a sizeable aggregate effect.
39
numbers. This includes but is not limited to hiring outside specialists and consultants due to lack of
in-house knowledge and familiarity with IFRS, organizing conference calls and road shows for
investors, preparing press statements explaining differences in accounting policies, and redesigning
financial publications like annual and quarterly reports. It should be noted that, similar to the
implementation of SOX, the transition costs for U.S. firms could translate into large additional
revenues for financial reporting advisory and auditing firms. Not unexpectedly, many of these
advisory firms therefore take a very positive stance regarding the potential adoption of IFRS by the
U.S.
In addition, IFRS can affect state- and federal government-regulated industries like utilities,
telecommunications and financial institutions that provide financial statements to their regulators.
For instance, capital requirements for financial institutions are often determined on the basis of U.S.
GAAP financial statements. Furthermore, a switch to IFRS requires a re-evaluation of all explicit or
implicit contracts with components tied to accounting numbers.21 A switch to IFRS can also affect
managerial compensation schemes tied to reported earnings performance as well as debt covenants
with explicit references to GAAP numbers.22 Although the impact of IFRS adoption on the
magnitude of reported earnings of U.S. firms is ambiguous, studies from other settings suggest that
earnings volatility could rise, in particular if the switch to IFRS were to accelerate the use of mark-to-
market accounting (e.g., Hung and Subramanyam, 2007; Christensen and Nicolaev, 2008; Muller et
al., 2008). As a consequence, the likelihood of debt covenant violations could increase, requiring
costly renegotiations between lenders and debtors (Christensen et al., 2008). Note, however, that
21 From a mere legal perspective, the effects should in many cases be limited. If IFRS become generally accepted accounting principles in the U.S., any explicit reference to U.S. GAAP compliant numbers in contracts could extend
to reports prepared in accordance to IFRS, and no change in terminology is needed. 22 Large sample evidence in Dichev and Skinner (2002) suggests that about 40% of private corporate lending
agreements in the U.S. contain at least one accounting-based covenant.
40
contract implications seem most prevalent in the year of the transition, and are likely to abate over
time.
Overall, we expect transition costs for U.S. firms to be substantial, and to contain a fixed
component, thereby weighing more heavily on smaller firms. It is difficult to put a precise estimate
on the aggregate or per-firm transition costs. Based on survey data for the 2005 mandatory transition
to IFRS in the European Union, it is possible to construct an estimate of the first-time preparation
costs of IFRS consolidated financial statements for publicly traded firms. This evidence suggests
per-firm estimates ranging from 0.31% of total sales for firms with sales below $700 million to
0.05% of total sales for larger firms (ICAEW, 2007), which amounts to an average one-time cost of
$420,000 for small firms and $3.24 million for large firms.23,24 Based on these estimates, the
aggregate transition costs would amount to at least $8 billion for the U.S. economy as a whole.25 In
terms of the universe of affected firms, this estimate for the aggregate costs is conservative because
Compustat does not cover many firms trading in the over-the-counter (OTC) markets and hence our
estimate includes only exchange-listed firms. SEC-registered OTC firms will have to switch to IFRS
(or at least partially adjust their reporting) and, in relative terms, the switch is likely to be even more
23 We obtain these numbers using data from Compustat North America in 2005. Out of 6,822 individual firms with
total sales numbers available, 5,006 firms fall below the $700 million threshold, and 1,816 are above. We then
compute transition costs based on average total sales for each group, i.e., $136 million � 0.31% � $0.42 million (or
5,006 � $0.42 � $2,110 million) for small firms, and $6,484 million � 0.05% � $3.24 million (or 1,816 � $3.24 � $5,890 million) for large firms, respectively.
24 To compare these numbers to those outlined in the SEC Roadmap (SEC, 2008, p. 70848, estimated at $32 million per
company eligible for early IFRS adoption over the first 3 years of IFRS reporting), we also apply our approach to the
200 U.S. firms with the largest sales numbers in 2005. Based on average total sales for this group, the first-year
transition cost estimate increases to $17.98 million (i.e., $35,954 million � 0.05%). In the following years, the
recurring costs of preparing IFRS financial statements are estimated on the range of 0.06% of total sales for small firms to 0.008% of total sales for very large firms (ICAEW, 2007). Hence, we add $2.88 million (i.e., $35,954
million � 0.008%) for each of the following two years, yielding a 3-year transition cost estimate of about $24 million.
More generally, our computations show that the estimated costs vary considerably by firm size and hence one has to
be careful with comparisons of average estimates. 25 It should be noted that some of the transitional costs for U.S. firms translate into incremental revenues for financial
reporting advisory firms. Therefore, switching to IFRS will likely result in a redistribution of wealth among parties
in the economy. A potential concern for U.S. policymakers is whether a significant amount of the wealth is
redistributed to non-U.S. parties including foreign financial reporting advisory firms with pre-existing expertise in
IFRS implementation. We come back to this issue in Section 4.6.2.
41
costly for them (e.g., Bushee and Leuz, 2005; Leuz et al., 2008b). In addition, our estimate does not
include financial institutions, for which total sales is either not available or nor a good activity
measure. Obviously, all these estimates are only as good as the survey input data and, hence, they
should be interpreted very cautiously.26 Finally, we note that the costs are likely to increase even
further if the SEC requires firms to provide, for a limited period, IFRS reports together with
reconciliations to U.S. GAAP (or vice versa), as for instance Proposal B in the Roadmap (SEC,
2008).
4.3.2. Recurring Costs
Even though the one-time conversion costs are likely to be substantial, they by themselves are
unlikely to justify maintaining the current U.S. GAAP regime. If there are (modest) benefits to IFRS
adoption that continue to recur over the long-run and are sufficiently large, they will eventually
outweigh the start-up costs (assuming a reasonable discount factor). Hence, it is also important to ask
whether there are any major recurring costs from IFRS adoption, as they could substantially alter the
cost-benefit tradeoff. Given that U.S. GAAP comprise a comprehensive set of rules and regulations,
it is unlikely that on an ongoing basis the direct out-of-pocket costs for the preparation of IFRS
reports exceed those under the current system. If anything, one might argue that the direct costs go
down as a result of the lower complexity of IFRS. However, there may be recurring indirect costs
arising from incompatibilities with the U.S. legal and institutional system. Such issues would not be
easily fixed, as institutional changes take time and can result in substantial costs. In addition, there
can be opportunity costs related to a loss of innovation in standard setting arising from the lack of
26 Another caveat is that the transition costs of EU firms may not be representative for U.S. firms that operate in a
different institutional environment, as noted in Section 4.1.
42
competing accounting standards in the marketplace. We explore these indirect costs in Sections 4.5
and 4.6.
4.3.3. Cost Savings Arising from a Single Global Reporting System
U.S. firms with operations around the world may realize cost savings from using a single set of
standards for their financial reporting systems around the world. The foreign subsidiaries of U.S.
multinationals often have to comply with the domestic reporting standards of their domicile (e.g., for
statutory reporting or tax purposes). This introduces duplication of reporting systems and translation
costs for U.S. multinational firms. In particular, each foreign subsidiary would either (i) maintain
and track its primary accounts in compliance with U.S. GAAP (but then have to translate its reports
to the domestic GAAP of its domicile), or (ii) maintain and track its primary accounts in compliance
with the domestic GAAP of its domicile and then translate or reconcile these accounts to U.S. GAAP
for consolidation with the U.S. parent company’s accounts. As many countries have moved to IFRS
reporting for consolidated accounts but not yet for statutory purposes (or the parent-only accounts), a
foreign subsidiary of a U.S. multinational may have to maintain (or reconcile) three sets of accounts,
i.e., U.S. GAAP, IFRS and domestic GAAP. In these cases, switching to IFRS reporting by the U.S.
multinational could eliminate one set of accounts and hence could produce cost savings.27
Furthermore, there is the prospect that IFRS become the global set of accounting standards for
statutory and parent-only accounts as well, in which case IFRS adoption by the U.S. would enable
U.S. multinationals to maintain and track a single set of accounts, eliminating duplication and leading
to reporting costs savings.28 Thus, the magnitude of the cost savings of IFRS adoption by U.S.
27 Certain jurisdictions also allow the use of IFRS for statutory purposes. In addition, it should be noted that foreign jurisdictions typically accept U.S. GAAP for financial reporting purposes.- Thus, as an alternative, it would be
possible to eliminate one set of accounts by moving the subsidiary to U.S. GAAP. 28 IFRS reporting for statutory and parent-only accounts is still heavily debated around the world and, hence, this
prospect may be far in the future. One might therefore argue that these cost savings should not be given much weight
43
multinationals depends among other things on the future use of IFRS for statutory reporting around
the world (as well as the future acceptance of U.S. GAAP in foreign jurisdictions). Aside from the
cost savings, a switch to IFRS by a U.S. multinational likely also improves within-firm reporting
comparability across its subsidiaries to the extent that translated or reconciled U.S. GAAP numbers
prepared by the subsidiaries for the parent are not of the same quality as primary accounts in IFRS.
There are two additional points related to the possible costs savings from a single global
reporting system that are worth emphasizing. First, purely domestic U.S. companies are unlikely to
realize any international reporting costs savings from using IFRS compared to U.S. GAAP. Thus, the
costs and benefits from IFRS are not evenly distributed – an issue that we discuss in the next section.
Second, foreign multinationals that use IFRS will also realize incremental savings if the U.S. adopts
IFRS because their (publicly-listed) U.S. subsidiaries will no longer have to create duplicate financial
reports that comply with U.S. GAAP. Therefore, the adoption of IFRS by the U.S. can decrease the
costs to foreign multinationals from either establishing or purchasing a U.S. subsidiary.
4.4. Which Firms Are Likely to Have Larger Net Benefits (or Costs) from IFRS Adoption?
Empirical studies show that the costs and benefits of IFRS adoption are distributed
heterogeneously among firms (e.g., Daske et al., 2007, 2008). In this section, we discuss which U.S.
firms are likely to benefit the most (or have the smallest net costs). We start with existing evidence
on the determinants of voluntary IFRS adoption around the world to predict which U.S. firms would
likely incur larger net benefits (or smaller net costs) from adopting IFRS. The underlying assumption
in the decision of whether the U.S. adopts IFRS. The counterargument is that IFRS adoption by the U.S. could
substantially increase the chances of IFRS becoming the global set of standards for all kinds of reporting.
44
is that firms voluntarily switch to IFRS only if, in expectation, the benefits exceed the costs.29 Prior
research reveals that voluntary IFRS adopters are larger, more likely to have international cross-
listings, more extensively rely on outside funding, have geographically dispersed operations, more
diffuse ownership, and are more likely domiciled in countries with low-quality local reporting (e.g.,
Dumontier and Raffournier, 1998; Ashbaugh, 2001; Leuz, 2003; Cuijpers and Buijink, 2005;
Christensen et al., 2007). Many of these determinants are derived from contexts in which adopting
IFRS could improve reporting quality (relative to local GAAP reporting), which is not necessarily the
case for the U.S. For instance, the argument that firms switch to IFRS to reduce information
asymmetries and hence improve their ability to satisfy their current and future financing needs does
not really apply to U.S. firms and U.S. GAAP. The majority of U.S. firms can satisfy their financing
needs by tapping into the domestic capital market. It follows that the primary beneficiaries of IFRS
adoption should be U.S. multinational firms (as well as U.S. investors who want to diversify their
portfolios abroad and would no longer need to invest in understanding both U.S. GAAP and IFRS),
consistent with the notion of comparability benefits.
We broadly define “multinationals” as firms with foreign subsidiaries or operations, firms that
derive a significant portion of their sales abroad, firms considering international expansion, firms
with foreign suppliers or customers, and firms with a more international investor base. As discussed
in Section 4.3.3, for these firms, benefits could come in the form of avoiding costly dual reporting
when foreign authorities allow or require IFRS financial statements for statutory reporting purposes.
However, most countries have not yet moved to IFRS for statutory reporting. The latter is typically
based on the so-called individual (or parent-only) accounts under local GAAP, rather than based on
29 It should be noted that the overall proportion of voluntary IFRS adopters is small, averaging only about 6% of the
total Worldscope population between 1988 and 2004 (see Daske et al., 2007, Appendix A). This suggests that the
large majority of international firms did not expect to incur net benefits from voluntarily adopting non-local GAAP.
45
IFRS consolidated accounts (e.g., Nobes, 2008, for a classification of European countries that still
require national GAAP for unconsolidated accounts). Benefits could also arise from the removal of
formal or informal trade barriers that prevent foreign firms, investors, governments and other parties
from transacting with non-IFRS compliant U.S. firms, or at least make it more costly to do so.30 In a
similar vein, U.S. firms with cross-listings abroad, seeking to attract foreign investors or obtain
foreign finance might not have to prepare a separate set of financial statements.31
Another group of potential beneficiaries from IFRS adoption are large firms and those with Big
Four auditors. Since switching to IFRS likely involves a fixed-cost component, larger firms will be
at an advantage. Big Four audit firms are already experienced in implementing and auditing IFRS
reports and can rely on an international network of professionals for special issues. This gives them a
comparative advantage over local, non-affiliated auditors. On the other end of the size spectrum,
smaller U.S. firms could also benefit from the adoption of IFRS. IFRS are often touted as being less
complex than U.S. GAAP. Lower complexity means lower risk of errors and, on average, lower
audit costs.32
4.5. Compatibility of IFRS with U.S. Regulatory System, Legal Environment, and Economy
In this section, we discuss issues related to the compatibility of IFRS with the U.S. institutional
environment and infrastructure. There is a growing body of evidence that a country’s institutions,
30 Note that we can turn the “trade barriers” argument on its head and use it from a protectionist’s perspective against
IFRS adoption by the U.S. In particular, any formal or informal requirement of U.S. GAAP reporting imposes
additional non-tariff costs impeding foreign firms from entering the U.S. and conducting business with U.S. clients,
suppliers, investors or creditors. 31 The scope of the cross-listing argument is limited to requirements explicitly precluding U.S. GAAP reporting. On
many international exchanges U.S. firms are already allowed to report in accordance with U.S. GAAP (e.g., London,
Hong Kong, Frankfurt). In addition, as stated by the European Commission in 2008, U.S. GAAP meets the criteria
of equivalence to IFRS, effectively granting U.S. issuers the right to be listed in EU markets without costly reconciliation (reference: IP/08/619).
32 However, as discussed in more detail in Section 4.5.1, it is not clear whether IFRS will remain as simple and
principles-based when adapted to the U.S. environment, or whether the lower complexity is just a byproduct of its
relatively young age.
46
including its financial reporting regime, are important determinants of aggregate economic
outcomes.33 Furthermore, as discussed in Section 3.2, the fit among the elements of a country’s
institutional framework is likely important for the performance of a country’s financial and economic
system. As a result, a switch to IFRS by the U.S. could lead to unwanted consequences for the U.S.
economy if there are incompatibilities with other elements of the institutional framework, even when
IFRS are deemed to be high quality and perform well in other countries.
An imperfect institutional fit between IFRS and current U.S. institutions can also be a source of
both transitional and future recurring costs to the economy. That is, even if IFRS and U.S.
institutions are in principle compatible, certain U.S. institutions may need to be adjusted or adapted
so as to fine-tune them to the introduction of IFRS. As there are many institutions that use or rely on
firms’ reported accounting numbers, including the audit profession, regulators, enforcement agencies,
the legal system, tax laws, and private contracts, adjustment costs can be non-trivial. At the same
time, possible adjustments to current U.S. institutions could lead to greater efficiencies and
improvements of the system overall. Given the complexity of the interactions, the institutional
effects and adjustments arising from IFRS adoption are difficult to ascertain and quantify.
4.5.1. Accounting Discretion and the U.S. Litigation System
It is often argued that the major difference between IFRS and U.S. GAAP is that the former are
more principles-based compared to U.S. GAAP, which are often described as more rules-based. The
exact meaning of this distinction is not well defined and is often unclear. Moreover, in our view, it
potentially distracts from more fundamental economic arguments on the impact of accounting
standards. Similar to IFRS, U.S. GAAP are also based on certain principles (see, e.g., the FASB’s
33 See surveys by Shleifer and Vishny (1997) and La Porta et al (2000).
47
conceptual framework). Moreover, Ball (2008) argues that, contrary to popular belief, the U.S.
accounting system can be viewed as principles-based at the court level. He points to the 1969
criminal case of the U.S. vs. Simon in which the U.S. Supreme Court essentially adopted a principles-
based view of accounting.34 Thus, the evolution of U.S. GAAP to a more rules-based set of standards
could just be a result of age, and the demand for greater specificity and guidance gradually grew, as
the original standards were stress tested and further developed.
Nonetheless, there is little disagreement that current IFRS are less specific and provide less
application guidance than U.S. GAAP (e.g., SEC, 2008). As result, a key difference between the two
sets of standards is the amount of discretion that firms and managers have. As discussed in Section 4,
more discretion in the accounting standards is not necessarily bad. It can enable managers to convey
private information to the markets in a less costly fashion. On the other hand, discretion can allow
managers to pursue ulterior reporting motives. As countries’ institutional frameworks play a major
role in shaping managers’ reporting incentives and the use of discretion (see Section 3.1), it is
important to ask whether the amount of reporting discretion in IFRS poses a problem for the U.S.
litigation system, which is rather unique around the world (see Section 4.1).
As a result of less specific standards and guidance, managers must exercise more judgment in
interpreting IFRS, which could increase the incidence of legal challenges of managers’ (good-faith)
professional judgments.35 On one hand, a switch to IFRS could lead managers to make initially “less
aggressive” accounting choices given that the new parameters of U.S. litigation under IFRS have yet
to be established. The uncertainty about litigation outcomes could even induce managers to make
34 This view has been reaffirmed in recent court cases (e.g., WorldCom as outlined in Ball, 2008). This point notwithstanding firms and auditors often demand specific guidance from the SEC or the FASB in an effort to reduce
(perceived) litigation risks. 35 Similar to the litigation risk argument, managers’ professional judgments are also more likely to be challenged by
regulators, in particular the SEC (e.g., KPMG, 2008b).
48
overly conservative accounting choices. Furthermore, managers may undertake conservative
operating, financing, and investing decisions if they lead to accounting treatments under IFRS that
managers perceive as minimizing litigation risk. On the other hand, it is conceivable that the
transition from U.S. GAAP to IFRS leads to initially “more aggressive” accounting choices and more
earnings management because IFRS give managers greater latitude in interpreting and implementing
the standards. However, U.S. firms’ reporting incentives are shaped by many institutional factors and
these factors that are not expected to change around the introduction of IFRS. Therefore, it seems
unlikely that greater reporting discretion under IFRS alone would lead, on average, to more earnings
management across U.S. firms, but it can do so in cases where managers have poor reporting (or even
hiding) incentives to begin with.36 Thus, SEC enforcement and firms’ internal controls could become
more important as a result of IFRS adoption.
If there is a switch to IFRS, we expect the U.S. litigation system and accounting practices to
transition to a new equilibrium. Consistent with this expectation, current accounting practices and
GAAP generally reflect the present features of the U.S. litigation system (e.g., Basu, 1997; Ball et al.,
2000). Similarly, the amount of guidance in U.S. GAAP is often viewed as a response to the
litigation system. Thus, for a transition period, IFRS adoption is likely to impose some costs on the
parties involved. For instance, audit firms and financial reporting regulators (i.e., the FASB and the
SEC) may need some time to handle the ambiguities of IFRS and to develop new expertise.
Moreover, the pressures from the U.S. litigation system will shape the application and enforcement of
IFRS in the U.S., and likely create demands for additional implementation guidance. One such
example is the “forward-looking” risk estimates that firms are required to provide under IFRS. Since
36 Even if earnings management were to increase as a result of more discretion under IFRS, a potentially countervailing
effect is the occurrence of less transaction structuring and less real earnings management (Ewert and Wagenhofer,
2005).
49
U.S. GAAP do not require these estimates, their disclosure under IFRS could increase the exposure to
private litigation by investors. In sum, our prediction is that, if IFRS are exposed to the U.S.
institutional environment, there will be substantial pressures on the standard setters and U.S.
regulators to provide more guidance, details and rules.
4.5.2. Accounting Differences between U.S. GAAP and IFRS
Before discussing the effects and particular areas of differences between IFRS and U.S. GAAP,
it must be stressed that the two sets of standards have many things in common and that they are
considerably more similar due to the (formal and informal) convergence efforts of both standard
setters over the years. But in spite of the commonalities, several major differences between the two
sets of standards remain when it comes to particular transactions. Differences arise in how specific
items are recognized, measured, presented on the financial statements, and what disclosures are
needed. The Big Four audit firms provide updated lists of the differences between the two standards,
listing many differences.37 For example, according to PwC (2008), FIN 48 (Income Taxes) and FAS
123R (Share-based Payments) alone account for several of the key differences between U.S. GAAP
and IFRS. In addition, U.S. GAAP have an overlay of specific guidance for firms.
In an attempt to quantify the magnitude and direction of the accounting differences between the
two sets of standards, Plumlee and Plumlee (2008) analyze a sample of 100 firms randomly selected
from foreign private issuers that filed a 20-F with the SEC during 2006 and employed IFRS. Their
analysis indicates only a few categories of large reconciling items. Those areas are pensions and
post-retirement benefits, share-based compensation, revaluations of property, plant and equipment,
impairment losses on goodwill and intangibles, and deferred taxes. While the net income differences
37 See the summary of accounting differences between IFRS and U.S. GAAP by Deloitte (2008), Ernst & Young
(2008), KPMG (2008a) and PwC (2008). We have already discussed one major difference, i.e., the amount of
discretion that the two sets of standards offer in Section 4.5.1.
50
between IFRS and U.S. GAAP (netting across all the reconciling items for a firm) are on average
small and relatively concentrated (for more than half of the firms the differences fall within +/- 15%
of IFRS net income), there exist extreme cases with major differences ranging from -206% to +253%
of IFRS net income. For stockholders’ equity, the net difference is on average 10% (median = 2.7%)
with a similar distribution as the net income difference. Similarly, Gordon et al. (2008) examine 20-
F reconciliation amounts for cross-listed firms in the U.S. that use IFRS as their home-country
GAAP, and find that the five categories with the biggest differences are business combinations,
compensation, taxes, intangibles and the classification of debt.
In terms of direction, Plumlee and Plumlee (2008) find that 75% of the foreign private issuers
report IFRS net income in excess of U.S. GAAP net income.38 For stockholders’ equity, the
directional effect is less clear-cut: only 43% of the firms report IFRS values exceeding stockholders’
equity under U.S. GAAP. Conditional on being positive or negative, the average difference in
stockholders’ equity is substantial (i.e., +35.1% and -23.7%, respectively), and differs by firm size
and industry.
Thus, the effects of a switch from U.S. GAAP to IFRS on key metrics, such as net income, EPS
or stockholders’ equity, are difficult to predict for any particular firm. Moreover, while 20-F
reconciliations provide useful descriptive evidence on the magnitude and direction of the differences
between IFRS and U.S. GAAP, the findings are unlikely to generalize to the population of U.S. firms
and, hence, should be interpreted cautiously. Foreign firms with cross-listings in the U.S. are not
representative for the average U.S. firm. Cross-listed firms are typically large multinationals (e.g.,
Lang et al., 2003). Moreover, cross-listed firms may have incentives to reduce or even minimize
reconciliations (e.g., Leuz, 2006).
38 Gordon et al. (2008) also find that, on average, net income under IFRS exceeds net income under U.S. GAAP.
51
However, as discussed in Section 3.1, the importance of accounting standards for the quality of
reported accounting numbers is often over-estimated and the debate on IFRS adoption in the U.S.
often incorrectly focuses on narrow issues about differences in the standards. Instead, it is important
to highlight the reporting incentives argument. For instance, if a firm is forced to switch from U.S.
GAAP to IFRS but does not want to change the valuation of a particular asset, managers can try to
use reporting discretion to achieve the same valuation under IFRS. If this is not possible (e.g.,
because the asset cannot be recognized under IFRS), managers can attempt to compensate for the
recognition or valuation difference in this particular asset by using reporting discretion in other
assets. Finally, managers can always provide additional information, e.g., in the form of a
reconciliation schedule in the footnotes. While such additional disclosures are costly, they limit the
extent to which accounting differences matter for reporting quality.
Even if accounting differences between IFRS and U.S. GAAP are unlikely to have a major
reporting quality effect (see also Section 4.2), they can impede comparability and impose costs on
financial statement users. They can also have mechanical effects on contractual provisions and,
hence, require contractual adjustments. Finally, accounting differences could influence real
operating, investing and financing activities. For instance, firms may structure transactions
differently once they no longer obtain the preferred accounting treatment.
For this reason, we provide several examples of key accounting differences between U.S. GAAP
and IFRS, and discuss their potential impact on firms’ real decisions. It should be noted that these
differences are likely to decline over time as the IASB-FASB convergence project continues. Thus,
the relevant differences in accounting standards are not the ones based on current IFRS and U.S.
GAAP, but those in place at the proposed transition date.
52
First, a heavily debated issue is the use of fair values in IFRS and U.S. GAAP (e.g., Watts,
2003a, 2003b; Benston et al., 2006; Barth, 2008). One question in this regard is whether IFRS will
accelerate the trend towards fair-value accounting given that IFRS make more use of mark-to-market
approaches, and contain multiple instances in which the use of fair values is optional (e.g., IAS 16,
IAS 40). While fair-value accounting is in many ways conceptually appealing, it is often difficult to
implement (e.g., Ball, 2006), and could be incompatible with the current legal, institutional, and
political environment in the U.S. As the use of fair-value estimates is often viewed as increasing the
amount of discretion given to managers (e.g., Watts, 2003a, 2003b), the fair-value debate is closely
related to the issue of reporting discretion, which we have already discussed in Section 4.5.1.
Moreover, it is not obvious that the switch to IFRS indeed leads to more fair-value use. Consistent
with this argument, Christensen and Nikolaev (2008) show that around the mandatory adoption of
IFRS many U.K. firms abandoned fair values in favor of historical costs, while only a few German
firms used the newly granted discretion and switched from historical costs to fair values as a basis for
their valuation.
Second, in the area of revenue recognition, U.S. GAAP comprise very specific guidance
provided by the FASB and the SEC. These detailed standards include industry-specific provisions.
In contrast, IFRS only have two primary revenue standards plus a few interpretations on revenue
recognition that intended capture all revenue transactions. These principles apply without additional
details or specific provisions for particular industries. For example, in the software industry, U.S.
GAAP set out very specific rules and higher thresholds for recognizing revenue than IFRS. These
rules have affected the business and selling strategies of U.S. software companies, which in turn
implies that the adoption of IFRS could bring strategy adjustments for these firms (e.g., PwC, 2008).
Third, share-based payments are another area of significant differences. IFRS allow firms to
accelerate the expense recognition of certain stock options with “graded vesting” (e.g., Ernst &
53
Young, 2008). Consequently, some firms could restructure their compensation arrangements and
contracts in response to IFRS adoption, providing another example where accounting differences
could lead to changes in contracting and managers’ real operating decisions.
Fourth, the area of financial liabilities and equity gives rise to differences that could affect how a
firm chooses to raise capital. Certain financial instruments that are classified as equity under U.S.
GAAP have to be re-classified as debt under IFRS. The re-classification of these instruments will
affect reported net assets as well as debt to equity ratios (De Jong et al., 2006). Furthermore,
calculated interest expenses will sometimes increase under IFRS (and, in turn, decrease reported net
income) because the distributions no longer qualify as payouts to equity holders. These changes can
affect firms’ borrowing activities, debt covenants, ratings, and other contracts.
Finally, consolidations are another area of differences between U.S. GAAP and IFRS. Under
IFRS, the decision to consolidate is based on the principle of whether the company effectively has
control, i.e., the power and ability to dictate operating and financial policies of another entity. On the
other hand, U.S. GAAP provide many rules and exceptions that allow firms to avoid consolidation
and to place items “off balance sheet”. Therefore, IFRS adoption likely increases the number of
entities that have to be consolidated (e.g., Deloitte, 2008), potentially affecting firms’ acquisition and
investment strategies. Furthermore, the change in consolidation treatment can alter financial ratios,
which could necessitate mechanical adjustments to accounting-based contracts.
4.5.3. IFRS Reporting and U.S. Disclosure Requirements
Current FASB standards and additional SEC filing rules require far more disclosure than is
observed in many countries. To the extent that these disclosures exceed what is required under IFRS,
they do not create an incompatibility. That is, IFRS do not preclude additional disclosures. To the
contrary, the underlying principles of IFRS encourage disclosures that help paint a “true and fair”
54
picture of firms’ transactions, their performance and financial health. However, a switch to IFRS
poses the question of whether to maintain explicit SEC disclosure requirements that are outside or go
beyond those in IFRS.
As Hail and Leuz (2006) demonstrate, strict disclosure requirements that are well enforced are
associated with a lower cost of capital for firms that operate within these requirements. However,
they also show that the cost of capital reduction is larger in countries with less integrated capital
markets. As the U.S. market is one of the best integrated capital markets in the world and as U.S.
GAAP and IFRS already have demanding disclosure requirements, the cost of capital benefits from
additional disclosure requirements in the U.S. are likely to be muted. Moreover, disclosure
requirements are costly to firms and, hence, the usual cost-benefit tradeoff applies (see also Section
2.3). In this sense, the switch to IFRS provides an opportunity to review whether the current U.S.
disclosure requirements provide net benefits to U.S. firms and investors.
A more subtle issue is that disclosure requirements can change managers’ reporting incentives
and thereby indirectly influence the recognition and valuation of transactions in firms’ financial
statements.39 As such, additional disclosure requirements could be counterproductive with respect to
the goal of comparability. A counter argument is that additional disclosure requirements could be
used to bolster the quality of IFRS reporting in the U.S., if they are expanded in those areas in which
particular IFRS are a concern or viewed as insufficient. Furthermore, more stringent and specific
disclosure requirements could provide a way for the U.S. to distinguish its reporting environment
from other countries and allow the kind of leadership it had in developing accounting standards in the
past. The strictness of U.S. reporting requirements and enforcement has attracted many foreign firms
to the U.S. capital markets (e.g., Doidge et al., 2004; Karolyi, 2006; Hail and Leuz, 2009). Thus, the
39 For example, there is growing evidence that earnings management and good disclosure are negatively related (e.g.,
Leuz et al., 2003; Burgstahler et al., 2006).
55
SEC disclosure overlay provides benefits and opportunities for the U.S. but it also has costs with
respect to comparability, which need to be traded off against each other (see also Section 4.6.1).
4.5.4. IFRS Reporting and the Link to Taxation
The effect of IFRS on U.S. firms’ corporate taxes and on U.S. tax policy is an important area of
debate. Academic research has highlighted the potential interactions between a country’s tax
reporting system and its financial reporting system. For example, Guenther and Young (2000) and
Haw et al. (2004) suggest that a strong tax enforcement system within a country is associated with
higher-quality reported accounting numbers. On the other hand, it is unclear whether tax
enforcement leads to better financial reporting outcomes, or whether other (correlated) institutional
factors provide incentives to increase reporting quality that also lead to greater observed tax
compliance (Wysocki, 2004). Clearly, there are a number of strong institutions in the U.S. outside
the tax system, such as the well functioning legal system, the auditing infrastructure or the audit firm
oversight by the PCAOB, that likely foster tax compliance.
Even though we view high-quality financial reporting and tax compliance as correlated
outcomes, it is conceivable that the relatively strict tax enforcement system in the U.S. provides
incentives towards a higher-quality implementation of IFRS.
Aside from incentive effects, a change to IFRS can also affect certain tax calculations related to
financial statement numbers. As discussed in Section 4.5.2, income under IFRS differs from U.S.
GAAP income in the areas of revenue recognition, leases, asset impairments, classification and
measurement of financial instruments, hedging activities, and stock-based compensation. Many of
these items give rise to timing differences with regard to their treatment under the Tax Code and,
hence, will have an impact on the magnitude and time-series pattern of deferred taxes reported in the
IFRS financial statements.
56
Another difference arises in the area of uncertain tax positions. The IASB has explicitly stated
that it will not use the FASB’s requirements on uncertain tax positions in FIN 48 (e.g., PwC, 2008).
This raises the question of whether the U.S. is willing to give up its position and adopt current IFRS
provisions (i.e., IAS 12 on Income Taxes), whether the U.S. uses its weight to change IFRS to
include elements of current FIN 48, or whether it chooses a carve-out for IAS 12 and supplants it
with FIN 48. At the very least, the case of FIN 48 provides an interesting example of impediments to
the ongoing convergence between IFRS and U.S. GAAP.
Finally, there are IFRS-U.S. GAAP differences that affect the amount of taxes that firms pay
and, hence, have cash-flow consequences. One potentially important issue arises from the fact that
IFRS do not allow LIFO accounting. In contrast, U.S. tax law allows LIFO valuation but only if it is
also used for financial reporting. Presumably, a switch to IFRS would lead to a higher tax burden for
firms that previously used LIFO valuation, unless the tax system is adjusted. There are also
international tax impacts including, but not limited to fair value measurement, cash repatriations and
cash distributions through affiliates (e.g., PwC, 2008). In addition, there could be differences in state
and local tax positions (e.g., PwC, 2008).
The Internal Revenue Service (IRS) is likely aware of the tax-revenue implications of a possible
switch to IFRS, and it is expected that tax rules will be adjusted to compensate for any potential
revenue losses. The reverse is less clear, especially in times when overall revenues are declining.
However, for the LIFO issue, there are several relatively simple solutions. First, the IRS could drop
the requirement that LIFO is also used for financial reporting purposes. As such financial reporting
prerequisites are rare in the U.S. tax system, it is unlikely that dropping the LIFO conformity rule
57
imposes major costs on other elements of the tax system.40 Second, the IRS could provide tax credits
or tax breaks to firms that currently benefit from LIFO accounting but would incur higher taxes after
being forced to use IFRS. Thus, there are some transition costs for both the IRS and firms, as they
must adjust their tax planning strategies and tax reporting systems to the new rules. Moreover, if
there are real tax implications from IFRS adoption, they likely affect firms in an uneven manner as
their present tax burden not only reflects a firm’s financial and operating structure, but also
management’s incentives to minimize tax payments under the current Tax Code. Therefore, a shift in
the incentives structure is likely to affect management’s tax planning strategies.
4.6. Other Macroeconomic Effects
In this section, we consider other macroeconomic effects from IFRS adoption in the U.S. While
changes to a country’s reporting system in conjunction with changes to other institutions could have
broad effects on economic outcomes, IFRS adoption by the U.S. is unlikely to have a major
macroeconomic impact, such as GDP growth effects, because U.S. GAAP are already high-quality
reporting standards and the U.S. already has strong institutions. If there are any macroeconomic
effects of IFRS adoption, they are likely to arise in three areas: (i) the re-distribution of wealth
between different types of firms (e.g., internationally-oriented vs. purely domestic firms), (ii) the re-
distribution of wealth between different service providers (e.g., Big Four vs. smaller audit firms), and
(iii) comparability and competitive effects arising from the use of a single worldwide set of
accounting standards.41 As we have already discussed the potential wealth redistributions among
40 However, dropping the conformity rule will likely lead to more firms switching to LIFO for tax purposes, resulting in
revenue losses. 41 In addition, one might contemplate re-distributional effects in the labor markets. Some argue that IFRS adoption
would lead to higher reported earnings, which in turn could boost wage demands from employees and labor unions
(Wu and Zhang, 2008). However, such differences could be explained in a reconciliation schedule, and hence it is
uncertain, if not unlikely, that the wage demands would have much weight.
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firms in Section 4.4, we focus on the effects of IFRS adoption on the competitiveness of U.S. capital
markets, trade flows and foreign direct investments, service providers, and the educational system.
4.6.1. International Competitiveness of U.S. Capital Markets
Based on evidence from the cross-listing literature, it is not clear that U.S. capital markets were
hurt in the past by strict U.S. regulation or U.S. GAAP reporting requirements (e.g., Ammer et al.,
2005; Doidge et al., 2008; Piotroski and Srinivasan, 2008). To the contrary, the bonding literature
suggests that firms choose to cross-list in the U.S. because of its strict regulations and not in spite of
them (e.g., Reese and Weisbach, 2002; Doidge, 2004; Doidge et al., 2004; Hail and Leuz, 2009).
That is, the valuation and cost of capital benefits from U.S. cross-listings seem large enough to
outweigh the costs of reporting under U.S. GAAP or preparing 20-F reconciliations, particularly for
firms from countries with weak institutions and underdeveloped capital markets.
Based on this evidence, U.S. GAAP reporting requirements do not appear to be a competitive
disadvantage. Conversely, it is not clear either that moving to IFRS would make U.S. capital markets
more attractive to foreign firms.42 The SEC has recently decided to allow foreign firms cross-listing
in the U.S. to report under IFRS without a 20-F reconciliation, essentially granting them a choice
between U.S. GAAP and IFRS. This move raises the question of whether, based on fairness or
competition arguments, U.S. registrants should be given the same option. Even though giving a
choice to U.S. registrants does not involve the exactly same tradeoffs for the SEC as giving it to
foreign issuers, it involves similar issues. For instance, if foreign countries were to require the use of
IFRS reporting but not accept U.S. GAAP, U.S. companies that trade or operate in these countries (or
42 It should be noted that much of the evidence on the “attractiveness” of U.S. capital markets (including U.S. GAAP reporting requirements) was gathered in the years preceding widespread adoption of IFRS in Europe and other parts
of the world. Also, IFRS adoption might make U.S. markets more attractive to international investors that are not
familiar with U.S. GAAP. We have discussed this effect in Section 4.2.2. Effects on foreign direct investments and
trade flows are considered in Section 4.6.3.
59
would like to do so) would be forced to use IFRS in addition to U.S. GAAP.43 Furthermore,
international subsidiaries of U.S. firms may have to report under IFRS for statutory purposes. In this
regard, it is important to recall that most countries so far require IFRS only for the consolidated
financial statements of publicly traded firms but not for their parent-only accounts or for statutory
purposes. Thus, at present, many international (non-publicly traded) subsidiaries of U.S. firms still
have to report under local GAAP, which necessitates some form of restatement or reconciliation
regardless of whether the U.S. moves to IFRS or not. In the long run, however, IFRS reporting
requirements of international subsidiaries of U.S. firms are likely to become a bigger issue as many
countries are considering an IFRS mandate for private firms and for statutory reporting purposes.
Thus, it follows that if the U.S. maintains the current U.S. GAAP reporting requirement, more and
more U.S. multinational firms will either have to reconcile IFRS reports from foreign subsidiaries to
U.S. GAAP for consolidation purposes, or have to provide a reconciliation from the subsidiaries’
U.S. GAAP reports to IFRS for statutory purposes.
If, on the other hand, the U.S. adopts IFRS, we expect that regulatory competition will shift to
other elements of the reporting system, such as the enforcement of IFRS within a jurisdiction
(including penalties and investor remedies for non-compliance) or additional disclosure requirements.
The cross-listing literature suggests that, historically, many foreign firms have chosen to list in the
U.S. precisely for the bonding benefits arising from the relatively strict U.S. disclosure and
enforcement regime. Accordingly, these elements should be viewed as “assets” in the regulatory
competition with other countries. Similarly, one possible strategy for the U.S. would be to become a
leader for IFRS implementation and enforcement. However, this strategy likely creates a “U.S.
43 At present, we are not aware of a country that requires IFRS but does not accept U.S. GAAP for financial reporting
purposes, but it is possible that countries could introduce such rules in the future (e.g., for political reasons).
60
version” of IFRS and, hence, introduces incompatibilities with the reporting practices of foreign
firms (see also Section 6).
4.6.2. Effects on Service Providers
The infrastructure supporting U.S. corporate financial reporting is significant. It includes
financial and information intermediaries such as accountants, auditors, consultants, financial analysts,
investment bankers, and transaction-advisory service providers. For example, in 2006 there were
almost 300,000 accountants and auditors employed directly by U.S. accounting firms, tax preparation
firms, bookkeeping and payroll services firms, law firms and consulting firms.44 Direct and indirect
employment by other financial and information intermediaries is also significant with a large
concentration in the New York City area.
Much of this support infrastructure has developed around the current U.S. GAAP reporting
paradigm. Drawing upon homegrown U.S. GAAP expertise, the U.S. has become an exporter of
high-end services. This expertise has been in demand by foreign cross-listed firms and foreign firms
engaged in cross-border transactions. Moreover, U.S. accounting, auditing, consulting, banking, and
transaction-advisory firms have been highly successful in exporting their services around the world.
Arguably, U.S. adoption of IFRS makes the U.S. less unique and the resulting financial reporting
system will have many features in common with other countries including the EU. The adoption of
IFRS could therefore have negative competitive and employment implications for U.S. service
providers. However, there are also countervailing effects that need to be considered.
First, even without IFRS adoption by the U.S., foreign firms are unlikely to demand as much
U.S. GAAP expertise in the future. IFRS are now widely accepted around the world and demand
44 See the Bureau of Labor Statistic “Occupational Outlook Handbook” for the professions of Accountants and Auditors
(http://www.bls.gov/oco/ocos001.htm).
61
therefore has shifted to IFRS-related services. Thus, if the U.S. service providers are perceived as
lacking IFRS-specific capabilities, they will lose business to foreign competitors. Conversely, if the
U.S. maintains a version of U.S. GAAP that is substantially different than IFRS, then domestic
service providers would continue to have a “home field” advantage relating to U.S. GAAP services.
In addition, U.S. GAAP capabilities are likely to remain in close proximity to their U.S. client base,
reducing the risk of extensive off-shoring of services. Foreign financial intermediaries would also be
at a competitive disadvantage in a U.S. GAAP regime. Thus, in this scenario, we expect U.S. service
providers to essentially hold on to their domestic market share at the expense of building capabilities
to capture worldwide growth in IFRS-related services.
Second, the accounting and auditing industry is likely to generate additional business from a
transition to IFRS, and could be seen as primary beneficiary of such a decision. In particular, large
multinational auditors appear better positioned than small domestic auditors, which lack the IFRS
expertise and the international network to capitalize on IFRS services. That said, smaller auditors
could specialize in U.S. GAAP services to firms that are not subject to IFRS reporting requirements
(e.g., private firms) or firms that stick to U.S. GAAP in the event the SEC makes IFRS adoption
optional.
4.6.3. Effects on Trade Flows and Foreign Direct Investment
International trade and capital flows are affected by firms and investors weighing the portfolio of
institutional costs and benefits offered by various jurisdictions when planning where to operate,
invest or raise capital. The costs and benefits of a country’s accounting system are among the factors
likely to be considered by firms and investors. Thus, we discuss whether the adoption of IFRS in the
U.S. has predictable effects on trade flows, portfolio investment or foreign direct investments (FDI).
62
In terms of international trade flows, using the same accounting language might facilitate trade
of real goods between suppliers and customers. Ma�rquez-Ramos (2008) provides evidence consistent
with the notion that the accounting harmonization process in Europe has reduced information costs
and unfamiliarity between countries and, therefore, is one way of encouraging international trade and
FDI. However, these effects primarily apply to transitional economies that are moving away from
lower quality domestic GAAP to IFRS. In the case of the U.S., these “language” effects on trade are
likely to be small because both IFRS and U.S. GAAP are of high quality and already widely used and
understood around the world.
In the area of cross-border capital flows, the home-bias literature suggests that familiarity with
the accounting standards matters for portfolio holdings. Specifically, the adoption of high-quality
standards (including IFRS) is associated with higher foreign mutual fund and institutional investor
holdings, consistent with less home bias and a more efficient cross-border capital allocation
(Bradshaw et al., 2004; Aggarwal et al., 2005; Covrig et al., 2007). In addition, Cumming and Johan
(2007) provide weak evidence that the adoption of IFRS in Europe have facilitated cross-border
private equity investments. However, as Beneish and Yohn (2008) point out, it is difficult to sort out
whether these findings are mainly due to familiarity with a particular accounting system or due to
better information being produced by the new accounting system. Again, given the high quality of
U.S. reports, the effects on cross-border capital flows from IFRS adoption are likely to be small.
In the area of FDI (including multinational mergers and acquisitions), there are issues related to
both direct reporting costs and information processing costs arising from different financial reporting
systems across jurisdictions. For example, it is possible that U.S. firms are more apt to set up foreign
operations (rather than investing in the U.S.) or to acquire foreign firms if they are no longer required
to reconcile from IFRS for statutory reporting to U.S. GAAP for consolidation purposes. In other
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words, the direct reporting costs of foreign operations are likely to be lower if the U.S. switches to
IFRS and foreign jurisdictions increasingly move to IFRS for statutory reporting purposes.
The converse question is whether foreign firms are more likely to set up U.S. operations (or
acquire U.S. firms) if there exists an IFRS infrastructure in the U.S. The answer to this question
depends on whether U.S. subsidiaries of foreign firms have (statutory) reporting requirements tied to
U.S. GAAP. Contrary to many countries around the world, the U.S. does not have general statutory
reporting requirements. However, presently, there exist many federal and state regulatory rules for
private companies referencing U.S. GAAP or “generally accepted accounting principles.” At this
point, it is unclear if U.S. GAAP would continue as a distinct set of standards even after the adoption
of IFRS (e.g., for private firms) or whether IFRS would simply turn into “generally accepted
accounting principles” in the U.S. Regardless of this issue, foreign acquirers currently have to
operate two sets of accounts when purchasing a publicly traded U.S. company. In these cases, it is
conceivable that U.S. adoption of IFRS would promote FDI in the U.S.
4.6.4. Education System
A major issue surrounding the adoption of IFRS is whether it is possible to bring the accounting
profession, analysts, educators and other parties up to speed in a sufficiently timely manner so as to
have a smooth transition to IFRS (e.g., Barth, 2008; SEC, 2008). To the extent that there are
“educational” gaps, they would speak in favor of delaying IFRS adoption in the U.S. However, as
many other countries have experienced a relatively smooth transition of the education system to
IFRS, the same should be possible in the U.S., although the relatively large size of the U.S economy
and the diversity of its markets present particular challenges.
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Furthermore, the major accounting firms have already started an IFRS awareness campaign
among major constituencies and education providers.45 This campaign suggests that many auditing
and consulting firms are being proactive in their preparation for a potential IFRS adoption by the
U.S., irrespective of the view that these activities could also be self-serving.
Finally, the IFRS educational and training concerns apply mainly to preparers and the accounting
profession and less to capital-market participants. The latter group is already exposed to IFRS
through foreign companies and will become increasingly familiar with IFRS financial statements as
time passes. For example, academic studies on 20-F reconciliations (see Section 3) and studies of
mandatory IFRS adoption (e.g., Daske et al., 2008) suggest that investors can and already do cope
with differences in the accounting standards.
45 The Big Four accounting firms have released a number of reports indicating that IFRS education is lagging behind
(e.g., Ernst & Young, 2007b; KPMG, 2008b; KPMG/AAA, 2008). They warn that U.S. investors and issuers are not
yet sufficiently knowledgeable with IFRS, and that, at present, college curriculums, textbooks and other instructional
materials do not adequately train students and other interested parties in IFRS capabilities.
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5. Standard Setting and Political Ramifications of IFRS Adoption in the U.S.
Up to this point, we have not directly considered the process by which IFRS and U.S. GAAP are
established and how they develop. In this section, we consider issues related to the economics of the
standard setting process and ask whether a single set of global accounting standards is a desirable as
well as a feasible economic outcome. As the adoption of IFRS is not just an economic but also a
political issue, we further lay out the potential political, legal and institutional ramifications of
adopting (or not adopting) IFRS in the U.S. This includes discussions of the future role of U.S.
authorities (namely, Congress, the SEC and the FASB) in setting generally accepted accounting
principles and how the governance structure of the IASB may affect the future evolution of
international accounting standards.
5.1. Competition Among Standards and Standard Setters
A key role of accounting standards is to reduce the economy-wide transactions costs of
communicating information among various stakeholders, allowing them to make more efficient real
decisions and undertake transactions within, outside and between firms. At the same time,
accounting standards impose regulatory and compliance costs, and could increase the barriers to entry
into public capital markets. The academic literature discusses some of the tradeoffs of accounting
and disclosure regulation (see survey by Leuz and Wysocki, 2008).46 Much of the literature,
however, focuses on whether or not to regulate and how to regulate, but there is less work on
development of standards and the regulatory process.
46 See also the debate about the Sarbanes-Oxley Act of 2002 and related work (e.g., Rezaee and Jain, 2006; Leuz, 2007;
Li et al., 2007; Zhang, 2007; Leuz et al., 2008b).
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An important issue for this report is whether having a single set of accounting standards around
the world is desirable and would benefit firms, investors, and other stakeholders. As we discussed in
earlier sections of this report, moving to a single set of accounting standards can create some cost
savings and comparability benefits. However, there are also concerns related to the standard setting
process. One particular concern about the adoption of IFRS in the U.S. is that such a move would
largely eliminate the existing competition between IFRS and U.S. GAAP, essentially granting
monopoly status to IFRS.
The literature on the economics of accounting standards views monopolies as problematic for a
number of reasons (e.g., Ball, 1995; Dye and Sunder, 2001; Sunder, 2002, 2008; Benston et al., 2006;
Meeks and Swann, 2008; Stulz, 2008). A monopoly standard setter has few incentives to react
quickly to changes in the market place, to innovate, or to implement the best possible accounting
standards for investors. The monopoly can impede experimentation with alternative accounting
treatments, lead to an overinvestment in existing and new accounting standards without a proven
track record, and prevent specialization of standards geared towards a particular subset of firms.
Lacking an observable price mechanism to inform the markets and clearly defined criteria of social
choice, monopolistic standard setters also become prone to pressure from political lobbying.
Moreover, empirical evidence from firms opting out of their local disclosure rules by cross-
listing in the U.S. (e.g., Doidge et al., 2004; Hail and Leuz, 2009), from firms voluntarily replacing
domestic GAAP by IFRS or U.S. GAAP (e.g., Leuz and Verrecchia, 2000; Daske et al., 2007) and
from comparisons of mandatory disclosure regimes across countries (e.g., Hail and Leuz, 2006)
shows that regulatory differences affect firms’ and investors’ decisions, that firms attempt to take
advantage of these differences, and that there appear to be benefits from competition among regimes.
While opting out of a given regulatory regime is costly and is difficult for many firms, the mere
existence of an alternative reporting regime provides incentives for an incumbent standard setting
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body to pay attention to stakeholders’ needs. Thus, a functioning market mechanism mitigates
incentive problems and increases the responsiveness of standard setters, thereby fostering the
development of future standards and regulatory innovation.
If the U.S. adopts IFRS, lack of competition among standard setters could lead to pressures on
the IASB from its members and stakeholders to justify both its existence and the costs of maintaining
its operations. These pressures could yield an overproduction of standards by either revising existing
standards or developing new IFRS. Alternatively, the IASB could try to expand its influence by
venturing into new markets. The current project of IFRS for small and medium-sized private entities
could be seen as a step in this direction. Lacking an objective market mechanism, the evaluation of
such ventures is often arbitrary. Moreover, experience from other supranational institutions like the
World Bank, the International Monetary Fund or the United Nations suggest that a single global
standard setter will face mounting political pressure as consensus must be reached across a wide
range of political regimes and interests, likely affecting the issuance and evolution of accounting
standards (e.g., Werle, 2001; Charnovitz, 2005).
A related concern about a single set of global accounting standards is that the standard setting
process involves a compromise among a large and very diverse set of constituents across the world.
Different countries have different goals with respect to financial reporting regulation. While current
IFRS are arguably focused on the needs of “outside investor” economies such as the U.K., Australia
or the U.S., the majority of the economies around the world still relies heavily on close relationships
among a large set of stakeholders and is less focused on outside capital markets. A potential risk for
the U.S. and countries with similar “outside investor” models is that the IASB could be influenced to
modify IFRS to meet the demands of “inside stakeholder” economies. As a result, future IFRS may
be less suited for “outside investor” economies such as the U.S. and may fail to meet the needs of
companies and investors that rely heavily on arm’s-length transactions.
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Competition among standard setters or accounting standards can take on various forms and occur
at various levels (e.g., Benston et al., 2006). Currently, we face a situation of competition between
regional monopolies, namely U.S. GAAP in the U.S. versus IFRS for large parts of the world. One
could make the argument that IFRS have evolved into a set of high-quality standards and closely
resemble U.S. GAAP precisely because there already was a major competitor in the market place.
On the other hand, it seems unlikely that competitive forces from foreign standards (e.g., German
GAAP or U.K. GAAP) were the primary drivers behind the long history of innovative accounting
solutions in U.S. GAAP.47 For the most part, it is very difficult and costly for firms to opt out of their
home-country reporting requirements.48 Thus, at the country or regional level, competition among
standards does not take place unless countries are in the process of adopting a different set of
standards, or at least willing to consider such a move (e.g., Hope et al., 2006). That said, the
existence of multiple standard setters could nevertheless provide some discipline to the standard
setting process.
Alternatively, competition among standards can take place at the exchange level. Individual
exchanges can compete with each other by setting their own listing requirements. For instance, non-
U.S., non-U.K. firms can choose to cross-list on NASDAQ, NYSE, the London Stock Exchange’s
Main Market, or its Alternative Investment Market, each with different admission criteria, reporting
rules and oversight consequences (e.g., Piotroski and Srinivasan, 2008). The choice of listing venue
likely conveys information to the markets and allows firms to cater to specific investor clienteles.
However, as pointed out before, firms generally have to satisfy home-country reporting requirements
47 A more likely explanation is the U.S. institutional framework that created a demand for high-quality reporting. We
come back to this point at the end of this section. See also the discussion of institutional complementarities in Section 3.2.
48 Cross-listing often involves opting into a set of foreign reporting requirements, but at the same time firms remain
subject to their home-country accounting standards. To completely opt out, firms essentially have to incorporate in
other countries.
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unless they incorporate abroad or choose the foreign exchange as their primary listing venue. Thus,
generally, firms can voluntarily opt into stricter regimes but cannot easily escape to weaker regimes,
which limits the competition among accounting standards at the exchange level.
As a third possibility, competition among standards and the choice of accounting standards can
take place at the firm level. In this case, firms are able to select among a pre-specified set of
accounting standards the ones that best fit their needs, i.e., offer the highest net benefits (lowest net
costs). It is at this level where the arguments in favor of competition discussed earlier most likely
apply.49 They are much less convincing if competition takes place among regional monopolies that
are supported by the regional governments. But with a few exceptions like Germany and Switzerland
during the 1990s, we have not seen this type of competition among standards within a single
economy and therefore do not have much empirical evidence on its consequences.50
Furthermore, we should note that allowing for competition between different providers of
accounting standards, regardless of the level at which the competition takes place, is not without
problems. Some of the arguments against competition among accounting standards include the fear
of a “race to the bottom” leading regulators to loosen existing rules, the view that accounting
standards give rise to a natural monopoly due to comparability benefits and network externalities, as
well as concerns about the absence of a real market for accounting standards and the non-profit status
of the standard setting bodies (e.g., Dye and Sunder, 2001; Sunder, 2002; Benston et al., 2006).
Another limitation of the competition argument and the long-run co-existence of U.S. GAAP and
IFRS is that U.S. GAAP could become an ineffective competitor relative to the increasingly
dominant IFRS (see also Sections 6.1 and 6.7). At present, foreign countries seem to be “voting for
49 One way to achieve such competition in the U.S. would be to allow a choice between IFRS and U.S. GAAP for U.S.
firms. See Sections 6.2 and 6.3 for more discussion. 50 See, e.g., Leuz (2003) for a study of Germany’s New Market in which U.S. GAAP and IAS were competing.
70
IFRS with their feet.” This suggests that either current U.S. GAAP standards, while well suited for
U.S. firms and the U.S. environment, do not meet the needs of companies in other jurisdictions, or
countries do not feel their current and future needs being adequately represented in the U.S. standard
setting process. The declining relative market share could turn U.S. GAAP into a non-credible
alternative for multinational firms operating around the world. It is also possible that the
convergence process between the FASB and the IASB has brought the two standards already too
close together and, as a result, the choice to adopt either U.S. GAAP or IFRS by other countries is
primarily a political decision driven by considerations such as the amount of influence on the
standard setting process.
Finally, from a more pragmatic standpoint and setting the issue of desirability aside, we can ask
whether having a single set of globally accepted accounting standards is indeed the likely outcome.
Based on our discussion in Section 3, we expect incentives and institutional factors to remain a
driving force of reporting practices in the years to come. Hence, adopting IFRS on a worldwide scale
will hardly eliminate all national, industry and firm-level forces and incentives that influence firms’
financial reporting practices. Local capital markets, enforcement institutions and economic forces are
simply too strong and diverse, making a uniform implementation of IFRS around the globe highly
unlikely (e.g., Ball, 2006; Nobes, 2006; Daske et al., 2007 and 2008). Moreover, globally adopting
IFRS likely shifts regulatory competition from the creation of accounting standards to the
interpretation, implementation and enforcement of existing IFRS in local markets. These forces
could lead to regional versions of IFRS or different de-facto standards. For instance, financial crises,
new business practices or innovations in the capital markets can require changes or new
interpretations of extant IFRS, which in turn might lead certain countries to opt out or adopt their
own version of IFRS. The carve-out of specific sections in IAS 39 (Financial Instruments) during the
endorsement process of IFRS by the European Commission in 2004 and 2005 is just one example of
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such a nationalized version of IFRS, which sets an important precedent (e.g., Armstrong et al., 2008).
The recent financial crisis presented the IASB with the threat of another EU carve-out (Tweedie,
2008).
Pressures from the capital markets and new business practices can also help explain why U.S.
GAAP, notably a local monopoly for listed U.S. firms, have evolved into a high-quality set of
accounting standards. As discussed in Section 4.2.1, the needs of investors and other participants in
U.S. capital markets are an important driving force of U.S. accounting standards and practices. That
is, the same market and institutional forces that shape managers’ reporting incentives are likely to be
the primary drivers for reporting innovations and the development of standards, rather than regulatory
competition among standards from different countries or regions. These forces would remain in
place and continue to exert pressures on standard setting if the U.S. decides to adopt IFRS.
5.2. Political Ramifications of IFRS Adoption in the U.S.
A potential political benefit for the U.S. from IFRS adoption is that it signals an additional
willingness on the part of U.S. policymakers to cooperate with other major countries on important
global issues. However, there are also political risks for the U.S., which we discuss below.
Under the current system, U.S. Congress has delegated oversight over public security offerings
and the security markets to the SEC, which in turn has delegated the development of accounting
standards to the FASB. The SEC supervises this process, effectively retains veto power with respect
to the use of standards by U.S. firms, provides implementation guidance and monitors the conformity
of the financial reporting practices by publicly listed firms with the standards. In addition, the SEC
issues additional disclosure requirements for publicly traded firms that are registered with the SEC.
A switch to IFRS reporting in the U.S. would certainly affect the complex interplay of these
institutions as well as create an additional player with a formal standard setting role. IFRS are set by
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the IASB, which acts as an independent supranational standard-setting body appointed and overseen
only by the Trustees of the IASC Foundation.51 Although the IASB has pledged to cooperate with
national standard setters to achieve convergence in accounting around the world, there is little left for
individual rule-making bodies in a given country, at least as far as the standards themselves are
concerned, except perhaps to act as local agents or constituents of the IASB.52 In theory and without
further stipulations, this would also apply to the U.S. Congress and the SEC and, hence, transfer the
authority to set standards in the areas of accounting measurement, recognition and disclosure to the
IASB. Such a delegation of standard-setting power to the IASB, by its very nature, poses numerous
political challenges, beyond the economic aspects that we have discussed so far.
Legislative bodies like the U.S. Congress have an innate resistance to give up power to a foreign
authority or standard setting body. One of the major concerns from a U.S. perspective is that foreign
governments and interest groups exercise an undue influence on the IASB and, consequently, the
formulation of IFRS. For instance, it is not clear that other countries have the same goals as the U.S.
when it comes to defining the role of accounting, or when they opted for IFRS to replace their
domestic accounting standards in the first place (e.g., Hope et al., 2006). As discussed in Section 4.1,
the U.S. economy has several unique features and the U.S. reporting system has evolved in concert
with these features. For instance, current U.S. GAAP tend to be very investor-oriented and capital-
market-oriented. In contrast, many foreign countries are less reliant on public equity and debt
markets and, hence, foreign governments may push for accounting standards that focus more on
51 Many viewed the lack of oversight by a securities regulator like the SEC as a flaw in the IASB governance structure
(e.g., Tweedie, 2008). In response to this perception, the Trustees of the IASB approved in January 2009 the creation
of a Monitoring Group, which comprises leaders from the SEC, the Japanese Financial Services Agency, the European Commission, and the International Organization of Securities Commissions (IOSCO).
52 Note that in many countries the mandate of IFRS reporting applies only to consolidated financial statements of
publicly listed firms. Statutory (or parent-only) accounts as well as financial reporting by private firms are explicitly
excluded, and therefore countries might still retain a national accounting standards regulator.
73
protecting employees or creditors’ interests. They could also put less weight on public or private
enforcement mechanisms that impose IFRS on firms in their countries.
Presumably due to similar concerns with respect to their economies, several countries and
regional entities, most prominently the EU, have put in place an endorsement mechanism for future
amendments of existing IFRS or the creation of new IFRS.53 This mechanism not only grants them a
veto right, but also levers their influence in negotiating changes to IFRS (e.g., Benston et al., 2006;
Chand and Cummings, 2008), as has been highlighted by the events related to the recent financial
market crisis. It is unlikely that U.S. Congress will forgo the option to implement similar
endorsement and veto mechanisms, especially in light of the fact that other countries already retain
such rights.54 While such endorsement mechanisms are a safeguard against undue foreign influence,
they tend to complicate and slow down the development and implementation of new IFRS.
Moreover, if the U.S. adds or opts out of certain IFRS provisions as part of an endorsement process,
this could bring us back to regional or national sets of standards (e.g., NAFTA-version vs. EU-
version of IFRS). Such a regionalization of IFRS goes against the stated goals of creating a global
set of accounting standards that facilitates cross-border comparability around the world.
In the past, the IASB’s membership and organizational form generated IFRS that were and are
largely consistent with the market needs of “outside investor” economies such as the U.S. In
addition, the inherent competition between the IASB and the FASB, as well as the dialogue between
these two bodies as part of the convergence project, acted to discipline the process for setting current
IFRS. However, a significant risk for the U.S. is that the dynamics of the IASB may change in the
53 For instance, in Australia, accounting standards are part of the law and the parliament has delegated the task of rule
making to the Australian Accounting Standards Board (AASB). Retaining reference to Australian Accounting Standards in the law together with retaining the function of the AASB act as safeguards to preserve the legislator’s
veto rights, while at the same time the Australian accounting standards are essentially equivalent to IFRS. 54 In the past, the U.S. and other large countries have exercised the right to opt out of certain rulings of international
governing bodies like the United Nations, the World Trade Organization or the International Atomic Energy Agency.
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future as its constituencies change and the future IASB membership includes greater representation
of “inside stakeholder” economies.55 This could result in a future incarnation of IFRS that is
incompatible with U.S. institutions and may not meet the needs of U.S. investors and companies.
Therefore, the U.S. must consider not only the current version of IFRS and the current structure of
the IASB, but also how IFRS and the IASB will evolve in the future.
This evolution is likely to be influenced, among other things, by the growing importance of
emerging markets like China, India and other developing nations. With the growing relative
capitalization of these emerging markets, it is expected that investors and companies in these markets
will command a greater say in future debates about firms’ disclosure choices and accounting
standards. That being said, it is also expected that investors’ needs in those markets will more
closely resemble the needs of U.S. investors, leading to a convergence of the systems. Regardless,
capital markets in the U.S. will continue to claim a sizable share of and influence on world capital
markets for years to come.
An additional concern is that foreign regulators provide interpretations of IFRS and
implementation guidance. Therefore, U.S. firms and authorities would have to monitor the actions of
multiple regulators and governing bodies around the world. Moreover, based on the experiences of
other jurisdictions with the implementation of IFRS (e.g., KPMG, 2006; ICAEW, 2007; PwC/Ipsos
MORI, 2007), U.S. firms are expected to rely on extant SEC and FASB guidance in cases where
IFRS have gaps or are too vague, which could lead to fragmented international accounting practices.
Thus, even if all countries adopt a single set of accounting standards, there will be strong forces
55 One could argue that a refusal by the U.S. to adopt IFRS will accentuate this problem or trend. However, the sheer size of the U.S. economy, potential network benefits for non-U.S. firms, and the importance of the U.S. in the IASB’s
quest for truly global accounting standards could serve as mitigating factors, ensuring that the interests of U.S.
investors are still considered even if the U.S. decides against IFRS adoption at this point (but keeps open the
possibility to do so in the future).
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toward local adaptation of IFRS and differences in the de-facto standards. It is important to note that
these forces not only exist with respect to IFRS implementation at the firm level (as discussed in
Sections 3, 4.2 and 4.3), but also at the country level with respect to local regulators and governing
bodies.
From the preceding discussion, it is clear that the future roles of the SEC and the FASB need to
be redefined if the U.S. adopts IFRS.56 Aside from their involvement in the development of future
standards, it is expected that both bodies would continue to weigh in on the implementation of IFRS
(e.g., in the form of SEC Staff Accounting Bulletins or via the FASB’s Emerging Issues Task Force).
In addition, the SEC will play a role in the governance structure of the IASB as part of the newly
approved Monitoring Group.
Moreover, SEC and FASB guidance could serve as instruments to require tighter disclosure
standards for U.S. firms (e.g., in the areas of management compensation, board independence, etc.).
Unlike specific recognition or valuation requirements, adding disclosure requirements on top of IFRS
does not hurt comparability (at least not directly). They are rather a way to customize IFRS reporting
to the U.S. environment, and enable the U.S. to lead the way in terms of corporate transparency, and
to build on its competitive advantages. However, such supplementary disclosure requirements likely
change firms’ reporting incentives and, hence, indirectly affect firms’ reporting practices, which in
turn can hamper the comparability of U.S. financial reports. Thus, in thinking about additional
56 In addition, there exist areas where current legislation in the U.S. may be inconsistent with IFRS or with delegating
standard setting power to the IASB. For instance, under Section 108 of the Sarbanes-Oxley Act, the SEC retains the
authority to establish accounting principles or standards for purposes of enforcement of U.S. securities laws and, unless the law is changed, the IASB would have to accept SEC oversight. Because many SEC rulings are specific to
U.S. GAAP and have no IFRS counterparts, the SEC, in its roadmap, has started to identify areas which require
changes in an IFRS regime and has proposed initial amendments to existing rules and forms (SEC, 2008). However,
additional amendments and new guidelines will likely be necessary.
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disclosure requirements, the key tradeoff is assuring an appropriate reporting quality in the U.S.
versus achieving comparability of U.S. reports with the rest of the world.
If the goal is to follow this competitive strategy without sacrificing some of the comparability
benefits discussed in Section 2, both the SEC and the FASB need to evaluate their interactions with
the IASB and aim for more influence and cooperation. Close cooperation between the IASB and the
FASB has intensified since 2002 with the signing of the Memorandum of Understanding. A switch
to IFRS can potentially strengthen the U.S. influence. However, other countries could resist a high
level of SEC or FASB involvement, and some already argue that the level of cooperation has become
too intense (e.g., Chand and Cummings, 2008).57 Aside from bolstering the capital-market and
investor-orientation of IFRS, a strong U.S. influence could in the long run move IFRS closer to a
system of standards that is similar in nature to current U.S. GAAP, i.e., a system where specific rules
gradually supplant the more generic principles of existing IFRS.
Another widely recognized concern about the IASB is whether its present funding structure is
appropriate (e.g., SEC, 2008). At the moment, private corporations instead of government entities
provide the majority of funding on a voluntary basis. While switching to a more permanent source of
funding can address certain resource constraints, there are also other issues to consider such as
political influence, lobbying and holdup problems. On one hand, to maintain its independence, the
IASB might consider expanding its own capacity and capabilities as currently it outsources much of
its research to national standard setting boards. On the other hand, the IASB could retain its
relatively lean organization and put the expertise of national standard setting bodies to use by
delegating specific tasks to local authorities like the FASB and only assuming a coordination role.
However, such a strategy would likely slow down the standard setting process and make it harder for
57 Currently, three out of the 13 members of the IASB and five out of the 22 trustees of the IASC foundation have a
U.S. background.
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the IASB to resist the influence of local interest groups. As the future governance structure of the
IASB is currently in flux, it is difficult to render opinions on the likely outcomes. However, lessons
can be learned from the organizational and governance choices and resulting successes and failures of
other international governing bodies such as the UN, World Bank, or OECD, as well as the current
governance structure of the FASB. It seems that economic and political independence is an
important guiding principle in institutionalizing a standard setting body that is responsive to the needs
of investors and capital markets. Equally important is the role of an effective securities regulator that
monitors the development and implementation of the standards, thereby providing strong incentives
for transparent and truthful reporting.
Finally, a switch to IFRS by the U.S. also faces substantial political challenges within the U.S.
The lobbying view of regulation suggests that various stakeholders will weigh in on the process
depending on their benefits and costs from either maintaining the status quo or adopting IFRS.
Therefore, various stakeholders have incentives to lobby for a particular agenda because the decision
to adopt or forgo IFRS will have re-distributional effects across these stakeholders. For example,
large multinational firms are likely to lobby in favor of IFRS adoption given the potential cost
savings and comparability benefits from using a uniform set of standards throughout their global
operations. International auditing and advisory firms are also likely to support IFRS adoption given
their prior experience with IFRS in other countries and the significant revenues that a switch to IFRS
will generate during the transition period. On the other hand, smaller local auditors or domestically-
oriented U.S. firms may lobby against IFRS adoption. As such, the lobbying activities will provide
useful information about the costs and benefits of various constituents, and undoubtedly influence the
U.S. Congress in its decision on the future direction of U.S. financial reporting.
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6. Possible Future Scenarios for U.S. Accounting Standards
In this section, we outline several possible scenarios for the evolution of financial reporting
standards in the U.S. We discuss how the various economic and policy factors identified in this
report will likely play out in each of the scenarios and highlight the interactions and tradeoffs
between them. Towards this goal, the scenarios are intentionally stylized. It should also be noted
that they are neither exhaustive nor mutually exclusive. Furthermore, our discussion should not be
seen as advocating specific scenarios or actions.
As we outline the scenarios, we highlight: (i) possible outcomes for financial reporting quality
and comparability, (ii) the role of incentives in determining financial reporting outcomes, (iii) how
complementary institutions influence reporting outcomes and whether a scenario is compatible with
existing U.S. institutions, (iv) potential transitional and long term costs of a scenario, and (v) policy
and macroeconomic implications associated with a scenario.
The scenarios we discuss are: (1) maintain U.S. GAAP with acceptance of IFRS for foreign
firms, (2) maintain U.S. GAAP with a new IASB-FASB agreement to accelerate convergence
between IFRS and U.S. GAAP, (3) choice between IFRS and U.S. GAAP, but require reconciliation,
(4) unrestricted choice between IFRS and U.S. GAAP, (5) “U.S. IFRS” – require IFRS for all firms
plus an SEC/FASB overlay that provides guidance, additional disclosure requirements, and, in some
cases, supplemental standards, (6) flexible timetable to fully adopt IFRS, and (7) International U.S.
GAAP (I-GAAP) – a competing set of international standards (drawing on the foundation of U.S.
GAAP) designed to meet the needs of the U.S. and other countries. Scenarios (1) through (6) can be
viewed as an ordering from minimal to more extensive IFRS adoption. Scenario (7) is “outside the
box”, and suggests a more proactive U.S. strategy to influence the direction of regional and
international financial reporting, disclosure and enforcement standards.
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6.1. Maintain U.S. GAAP
This scenario maintains the requirement that U.S. firms file financial reports compliant with U.S.
GAAP (which, at the present time, are different from IFRS). It is nevertheless dynamic because,
consistent with past trends, both U.S. GAAP and IFRS will evolve and change in the future.58
We perceive the following issues and outcomes under the scenario where U.S. public companies
continue to file reports under U.S. GAAP. First, the comparability of U.S. financial reports will
likely increase internationally because more countries plan to adopt IFRS and differences between
IFRS and U.S. GAAP are smaller than differences between U.S. GAAP and other countries’
domestic GAAP. However, there will be residual differences among IFRS and U.S. GAAP and,
hence, some comparability issues at the standard level remain. These differences in the standards
likely impose some costs on both U.S. and foreign investors wishing to compare U.S. and foreign
firms. Given the sheer size of the U.S. capital markets and the large number of U.S. firms, it is likely
that foreign investors will, at least in the short and medium term, continue to maintain bilingual
capabilities between IFRS and U.S. GAAP in this scenario. Conversely, growing IFRS adoption
around the world suggests that U.S. investors must also develop and improve such bilingual
capabilities. In addition, we expect institutional differences to persist across countries. These
differences will continue to affect both firms’ reporting incentives and reporting outcomes. Thus,
even among IFRS countries, financial reports will not become fully comparable, requiring U.S. (and
foreign) investors to understand the heterogeneity among institutions and reporting practices around
the world.
58 The recent financial crisis provides a good example of how accounting standards are affected by changes in capital
market conditions and the political landscape.
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Second, we expect the direct capital-market effects of maintaining U.S. GAAP (relative to a
switch to IFRS) to be minimal. The reasons, established in Section 3, are that a switch to high-
quality reporting standards has measurable effects only in countries where IFRS are a major
improvement over the local standards and only if complementary institutions, like enforcement,
change at the same time or at least support the introduction of IFRS. However, both of these
conditions seem not to apply to the U.S. Current U.S. financial reporting is already of high quality,
and we do not foresee a major change to U.S. enforcement institutions, which are among the
strongest in the world, following a potential switch to IFRS.
Third and closely related to the above point, we do also not foresee major changes to the
reporting incentives of domestic firms and foreign private issuers in the U.S. As highlighted in
Section 3.1, incentives play an important role for financial reporting practices, arguably even more so
than stated accounting standards. Hence, unless incentives fundamentally change, high-quality
financial reporting in the U.S. persists regardless of IFRS adoption by the U.S. and accounting trends
abroad. Similarly, the mere adoption of IFRS by other countries does not imply immediate
improvements in the quality and comparability of foreign firms’ financial reports.
Fourth, in the short to medium term, this scenario does not introduce major (incremental)
adjustment costs. As discussed in Sections 3.2 and 4.5, the interplay between U.S. GAAP and other
legal, regulatory, enforcement and private sector institutions in the U.S. have jointly evolved over
time, creating a relatively efficient system of complementary checks and balances for financial
reporting and other elements of the U.S. institutional framework. This system is expected to continue
to operate relatively efficiently if U.S. GAAP continues to be used over the short to medium term.
Fifth, in the long run, the “maintain U.S. GAAP” scenario forgoes potential cost savings for
some firms and (modest) comparability benefits for all U.S. firms (and investors) from moving to
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IFRS. That is, for a select group of U.S. firms, costs are likely to be higher compared with an IFRS
adoption scenario. This group comprises multinational firms that want or have to use IFRS for their
foreign operations (see Section 4.4). A potential remedy is to allow an exemption for U.S.
multinationals that (i) wish to report under IFRS, and (ii) have significant foreign operations.
Sixth, the macroeconomic outcomes of the “maintain U.S. GAAP” scenario are likely to be
mixed. In the services area, financial and information intermediaries (auditors, analysts, etc.) have to
maintain U.S. GAAP capabilities, presumably in close proximity to their U.S. client base, thereby
reducing the risk of extensive off-shoring (see Section 4.6). Foreign financial intermediaries, on the
other hand, would be at a competitive disadvantage. At the same time, U.S.-based service providers
could suffer internationally because they lack specific or sufficient IFRS expertise. Thus,
maintaining U.S. GAAP can be viewed as a non-tariff trade barrier between U.S. and foreign
markets. In the education realm, U.S. GAAP capabilities keep their priority, but there would also be
a demand for expanded IFRS offerings in the curriculum to meet the needs of international markets.
Seventh, maintaining U.S. GAAP allows U.S. legislators (i.e., Congress and the SEC) to retain
unrestricted control over domestic financial reporting, and likely increases their bargaining power in
future negotiations with the IASB. In addition, the maintaining U.S. GAAP could be seen as a way
to promote competition between standard setting bodies.59 However, as discussed in Section 5.1,
competition among regional monopolies of accounting standards is likely limited. In addition, (i)
foreign countries seem to be “voting for IFRS with their feet” suggesting that the current form of
U.S. GAAP and the U.S. standard setting process do not meet the needs of other countries; and (ii)
59 Alternatively, maintaining U.S. GAAP could be viewed as a way to maintain the convergence process between IFRS
and U.S. GAAP, which arguably has been a force in the development of accounting standards as well. We discuss
this aspect in Section 6.2.
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the declining market share of U.S. GAAP could turn them into a marginal competitor in the
international domain.
Finally, foreign countries are likely to perceive the U.S. as non-cooperative in a multilateral
effort to harmonize accounting standards if it retains U.S. GAAP, which has political ramifications,
potentially beyond accounting. However, it should be noted that maintaining U.S. GAAP in the near
term does not rule out the pursuit of other scenarios in the future, and this scenario can therefore be
viewed as a “deferral” option.
6.2. Maintain U.S. GAAP with Continued Convergence between IFRS and U.S. GAAP
This scenario also maintains the requirement that U.S. firms file financial reports compliant with
U.S. GAAP but adds the element of accelerated convergence between IFRS and U.S. GAAP. In the
short run, the first six issues from the pure “Maintain U.S. GAAP” scenario will likely also to apply
to this scenario. However, many of the issues dissipate as U.S. GAAP and IFRS eventually
converge. The key difference between this scenario and the earlier scenario is that U.S. authorities
renew their commitment to the “convergence project” with the IASB in 2011. Additionally, the
following issues become relevant.
First, in the near term, the SEC and FASB maintain their influence on U.S. financial reporting,
possibly increasing their bargaining power in negotiations with the IASB relative to being simply one
of many constituents of the IASB (see Section 5). In this scenario, some competition between the
two sets of standards remains. However, it is likely to be considerably weaker due to the existence of
a formal convergence process. Moreover, the beneficial effects of competing standards diminish as
the remaining material differences between IFRS and U.S. GAAP disappear as part of the
convergence project (see Section 6.1). Aside from competition, the convergence process itself can be
a source for improvements in financial reporting standards, as it has been in the past. But again, this
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force and the influence of the U.S. on future standards is likely to weaken over time, as the remaining
differences between U.S. GAAP and IFRS become smaller.60
Second, this scenario can be viewed as a phased adoption of IFRS with substantial U.S. input on
the eventual form of IFRS. As U.S. GAAP are slowly modified to converge with IFRS, U.S.
stakeholders have sufficient time to adapt to the changes. This approach is likely less costly (in
present value terms) and creates less extreme disruptions for firms, investors and the reporting
infrastructure, reducing the aggregate transition costs (see Section 4.3). For instance, contractual
agreements tied to accounting numbers do not have to be re-written immediately because U.S. GAAP
gradually change over time. On the other hand, the benefits of reporting comparability will also be
realized more slowly and there will be continuous changes due to the convergence process (beyond
the normal rate of change in the accounting standards).
Third, this scenario gives rise to a number of implementation issues including (i) the extension of
and changes to the Memorandum of Understanding between the FASB and the IASB, (ii) the
resolution of disagreements between the two standard setting bodies on the convergence of more
contentious standards, and (iii) the timeframe for the complete convergence of IFRS and U.S. GAAP.
6.3. Allow Choice between IFRS and U.S. GAAP, but Require Reconciliation
Historically, the SEC has required foreign private issuers to either file financial statements in
accordance with U.S. GAAP or file their domestic GAAP reports together with 20-F reconciliations.
In this scenario, we outline potential issues arising from allowing U.S. firms the choice between U.S.
GAAP and IFRS with the supplemental requirement that firms opting for IFRS must provide
reconciliations to U.S. GAAP.
60 Of course, standard setters could still aim to improve the accounting standards over time, but these improvements
would be no longer driven by convergence per se.
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The academic literature on the relevance of 20-F reconciliations for investors has produced
mixed results (see Section 4.2). Thus, it is a priori not obvious whether reconciling from IFRS to
U.S. GAAP improves investors’ insights into U.S. firms’ operations. However, the “optional IFRS
plus reconciliation” scenario enhances the comparability of financial statements along two
dimensions: (i) all U.S. firms have “comparable” U.S. GAAP statements, and (ii) the subset of U.S.
firms that file primary reports under IFRS also has “comparable” statements with international firms
reporting under IFRS. Yet, as pointed out before, the comparability applies only to the accounting
standards themselves (see Section 3.1). Reporting incentives are likely to differ substantially not
only across IFRS and U.S. GAAP firms, but also within each group. As a result, we do not expect
reporting outcomes to be fully comparable, even for firms providing reconciled numbers, and the
extent to which there are comparability benefits for firms and investors is difficult to predict.
Another argument in favor of reconciliation is that it disciplines the implementation of IFRS by
mitigating incentives to use the discretion inherent in IFRS in an opportunistic fashion. The counter
argument, however, is that firms could have incentives to minimize the reconciliation amounts they
have to disclose, which in turn can reduce the quality of both IFRS and the reconciled U.S. GAAP
numbers (Leuz, 2006). In a similar vein, it is precisely those firms that have to be “forced” to
disclose more information via a reconciliation for which the reporting incentives are weak and,
hence, the quality and informational value of the reconciliations are presumably low.
An argument in favor of reconciliation is that it educates investors about the differences between
IFRS and U.S. GAAP and, hence, facilitates the long-run transition to an IFRS regime. Moreover,
under this scenario all firms maintain some U.S. GAAP capabilities. If, at a future date, the SEC
decides to reverse course and no longer permits IFRS for U.S. firms, there should be relatively few
obstacles to reverting back to a U.S. GAAP regime.
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It is important to also consider the costs of a reconciliation requirement. Firms face the tradeoff
to choose the set of standards that delivers the highest net benefits, but, in case they choose IFRS,
have to bear the costs of reconciliations. These costs are non-trivial, especially if reconciliation
requires changes deep down in a firm’s accounting system. In light of the SEC’s recent ruling to
waive the 20-F reconciliation requirements for foreign registrants reporting under IFRS, it is not
obvious that the benefits of a reconciliation requirement outweigh the costs for domestic registrants.61
There likely are firms for which reconciliations have net benefits, but those firms can voluntarily
provide them to help investors understand the transition to IFRS. Given the additional cost burden,
we expect only a select group of firms to exercise the option to use IFRS for their primary financial
statements if reconciliation to U.S. GAAP is a prerequisite for IFRS adoption.
Finally, this scenario can be viewed as a transitional option leading to either unrestricted choice
between U.S. GAAP and IFRS (Section 6.4) or mandated full adoption of IFRS (Section 6.5). It
should be noted that there is also the converse path: allow both IFRS and U.S. GAAP, but require
reconciliation to IFRS for U.S. GAAP filers. This option may be a reasonable alternative to full
adoption of IFRS if (i) the U.S. intends to adopt IFRS in the long run, and (ii) many firms find that
reconciliations to IFRS are not as costly as a full mandated adoption of IFRS.
6.4. Allow Unrestricted Choice between IFRS and U.S. GAAP
In general, the “unrestricted choice” scenario provides greater flexibility to U.S. firms and allows
for firm-level competition between IFRS and U.S. GAAP within the U.S economy, which is likely to
be far more effective than competition among regional monopolies. In addition to the issues that we
have already discussed in Section 6.3, the following arguments apply.
61 It should be noted that the situations are not exactly the same because U.S. firms already produce U.S. GAAP
reports. Unlike foreign firms that intend to cross-list in the U.S., they do not have to build U.S. GAAP reporting
capabilities from scratch and they always retain the option to revert to U.S. GAAP reporting.
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The academic literature on voluntary disclosure (Section 2) argues that firms trade off the
benefits and costs in making their financial reporting choices. On one hand, firms can make “low
quality” reporting choices, but they ultimately bear the costs of these decisions, e.g., in the form of
higher costs of capital or lower valuations. On the other hand, firms can strive for high quality
reporting, but this choice comes with extra preparation and auditing costs and the revelation of
sensitive information to outside parties and competitors. The evidence from academic studies
suggests that firms carefully weigh these costs and benefits and, hence, allowing firms a choice of
standards can be individually beneficial. However, doing so introduces non-comparability at the
standard level in the sense that U.S. GAAP and IFRS reports co-exist among U.S. firms. But it is not
clear that these negative comparability effects are large relative to the heterogeneity that exists among
U.S. GAAP reports of U.S. firms, as suggested by the reporting incentives argument.
Moreover, it is important to ask about firms’ relevant peer group. If investors really want to
compare a domestically-oriented U.S. firm to a multinational U.S. firm, then a switch of the
international firm to IFRS reduces comparability. On the other hand, if the international firm is
compared with its global peers, then the loss in comparability to purely domestic U.S. firms should
not be an issue. While the reality probably lies somewhere in the middle, this example serves to
highlight the tradeoff. Furthermore, it should be noted that potential inconsistencies among U.S.
firms are mitigated by the fact that all U.S. firms continue to face U.S. legal and other institutions,
that these factors have a major influence on firms’ reporting practices and, as such, serve as a force
towards comparability among U.S. firms, regardless of the standards they follow.
The next issue is whether an economy with two sets of standards bears higher aggregate
transaction and social costs than an economy with just one standard. For instance, under this
scenario, the auditing industry must invest in dual auditing capabilities, potentially leading to overlap
and inefficiencies. To mitigate these issues, the auditing industry is likely to segment itself into
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large, multinational auditors specializing in IFRS and small, domestic auditors focusing on U.S.
GAAP.62 Investors also need to be able to understand the two sets of standards. In the U.S.,
however, investors are already exposed to differing accounting practices, e.g., by foreign firms cross-
listed on a U.S. exchange or by private U.S. firms. Finally, the educational system needs to develop a
comprehensive curriculum covering both IFRS and U.S. GAAP. Regardless, these bilingual
capabilities are likely to exist considering that the rest of the world is moving toward IFRS.
As many of the benefits from moving to a single set of accounting standards come in the form of
externalities and network effects, they require a sufficient number of participants and increase in
network size (see Sections 2.2 and 4.2). With two standards co-existing in the U.S., some of these
network benefits could disappear or become substantially smaller. However, this reduction in
network benefits likely affects firms reporting under U.S. GAAP more than IFRS filers, as the latter
benefit from joining the growing network of international firms using IFRS.
The “unrestricted choice” scenario enables competition in its purest form (see Section 5.1).
Thus, it provides standard setters with a market-based mechanism to assess their accounting
provisions. It can also be viewed as an intermediate stage leading to full IFRS adoption for all U.S.
firms. If enough firms switch to IFRS, then maintaining two sets of accounting standards eventually
becomes socially too expensive.
6.5. Adopt “U.S.-specific IFRS”
U.S. GAAP include but are not limited to the FASB’s statements of financial accounting
standards (SFAS), SEC guidance on the interpretation of these standards, and U.S. legal precedents
that influence current and future accounting practices. Arguably, these extra-FASB elements of U.S.
62 Note that this could create additional non-comparability with regard to firms’ audited financial statements.
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GAAP are the result of the forces of the U.S. institutional environment, e.g., the demand created by
the capital markets. It is expected that these institutional forces will continue to exist after the
adoption of IFRS, leading to a “U.S.-specific IFRS” scenario. In this scenario, IFRS provide the
foundations for U.S. accounting standards, but they are complemented by a SEC/FASB overlay of
IFRS interpretations and implementation guidance, which may sometimes based on current U.S.
GAAP concepts. In addition, there can be supplemental disclosure requirements and standards that
augment IFRS.
An advantage of this scenario is that it moves U.S. firms closer to IFRS-compliant foreign filers
in the U.S. and other international firms reporting under IFRS. However, the comparability is hurt by
the additional SEC/FASB overlay because local adaptations and interpretations of IFRS are generally
viewed as a step back in the global convergence process. But again, based on the incentives
arguments outlined in section 3.1, it is important to recognize that other factors aside from the
accounting standards are major determinants of financial reporting practices. As result, there will
likely be heterogeneity in reporting practices regardless of local adaptations of IFRS, and even under
“pure IFRS” adoption. Moreover, “U.S.-specific IFRS” is likely to result in a better fit with the U.S.
institutional environment. This benefit mitigates and could even outweigh the potential drawbacks
from a loss in comparability.
Recognizing that U.S. legal, regulatory, enforcement and private-sector institutions have evolved
over time to create a well-functioning system, the “U.S.-specific IFRS” scenario could be viewed as
compromise that draws on some of the features of IFRS but also maintains additional elements of
U.S. GAAP that have a proven track record. That is, this scenario attempts to reduce institutional
incompatibilities and, from a fit perspective, could be more workable in the U.S. than a set of “pure”
IFRS (see also Section 4.5).
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A U.S.-specific version of IFRS also induces some degree of competition and discipline into the
standard setting process because the SEC and the FASB maintain the option to augment IFRS with
“better” standards and disclosure requirements. The competition and discipline not only benefit U.S.
firms and investors, but can also work the other way round as the IASB and foreign stock market
regulators may wish to adopt the SEC/FASB supplemental accounting standards and disclosure rules.
It may also strengthen the U.S. position in future considerations by the IASB regarding additions to
or amendments of extant IFRS. Furthermore, we expect “U.S.-specific IFRS” to be more politically
palatable given domestic concerns about ceding complete control over U.S. financial reporting to a
foreign authority.
With respect to macroeconomic outcomes, the “U.S.-specific IFRS” scenario likely increases the
competitive pressures on U.S. financial intermediaries (auditors, analysts, etc), given that the U.S.
will, in large parts, adhere to IFRS standards and foreign service providers could be equally well
equipped to render IFRS-related advisory services. On the other hand, U.S.-based service providers
are in the medium term no longer at a disadvantage in international markets because of the IFRS
capabilities they develop for their U.S. clients. In the area of education, IFRS training has to be
complemented by knowledge of the additional standards applicable to U.S firms.
In terms of cost consequences, the “U.S.-specific IFRS” scenario should be less costly during the
transition phase and in the long run than unconditional IFRS adoption to the extent that many of the
elements of current U.S. GAAP and SEC disclosure requirements are carried over. A related issue is
whether the SEC would require foreign private issuers in the U.S. to meet the same supplemental
standards and disclosure rules as U.S. firms.
90
6.6. Set Conditional Timetable to Fully Adopt IFRS
If one views full adoption of IFRS by the U.S. as inevitable, then the only remaining issues relate
to the implementation strategy and the adoption timetable. The SEC’s “Roadmap” towards IFRS
reporting by U.S. issuers (SEC, 2008) proposes a relatively rigid schedule, i.e., only a limited number
of firms are allowed to adopt IFRS early and, once the SEC’s decision in favor of IFRS is made, the
transition dates for particular groups of firms are fixed. As an alternative, we consider a more
flexible and conditional transition to IFRS. In this scenario, the decision and the timing of full IFRS
adoption are endogenous.
We start with the observation that different firms face different costs and benefits of switching to
IFRS (see Section 4.4). Clearly, certain U.S. firms would prefer to switch quickly to IFRS while
others would rather delay IFRS adoption hoping that the transition costs decline. Hence, U.S.
policymakers could consider a two-stage process of IFRS adoption. In the first stage (e.g., lasting up
to 10 years), firms could voluntarily choose to switch to IFRS or keep reporting in accordance with
U.S. GAAP. In the second stage, firms not yet reporting under IFRS would be required to switch, but
only if certain pre-set conditions are met. Thus, the trigger for full adoption is endogenous in the
sense that it depends on firms’ decisions regarding IFRS adoption in the first stage. The key aspect
of this transition model is that the move to IFRS is conditional on the (voluntary) adoption patterns of
U.S. firms and, hence, a market outcome before the remainder of the firms is forced to adopt IFRS. It
allows setting the timetable based on the observed adoption patterns. The underlying assumption is
that the adoption patterns provide insights and further information on firms’ cost-benefit tradeoffs
and, hence, reveal the preferences of U.S. firms for IFRS adoption.
The two-stage approach has the potential to create positive cascade effects. Allowing low-cost-
of-IFRS firms to adopt early can convey positive externalities on other firms that have not yet
91
switched. For instance, auditors learn how to smoothly transition to IFRS, which reduces the
transition costs for firms that adopt IFRS at a later date.
On the other hand, the phased-in transition model could introduce uncertainties for firms,
investors, and other stakeholders because the final decision and the timing of the mandated switch to
IFRS are not fixed, but depend on firms’ behavior.63 To mitigate this uncertainty, policymakers
could specify the terms of such a “flexible switch to IFRS” scenario by (i) allowing a certain group of
large firms (e.g., S&P 500 firms) to choose between GAAP and IFRS in a pre-set timeframe (e.g.,
within three fiscal years), and (ii) setting a threshold that, if achieved, automatically triggers the next
stage (e.g., if more than 50% of the large firms choose to adopt IFRS, then require adoption for the
remaining large firms, else repeat stage one), which in essence allows firms and market participants
to form and revise expectations about the likelihood of IFRS adoption.
Finally, we note that the initial set of firms that are given a choice of IFRS adoption should be
chosen sufficiently large because the possible network benefits of a single set of standards arise only
when a large fraction of firms adopt the new set of standards (see Section 4.2.2). Thus, the current
SEC proposal that only makes a small number of firms eligible for early IFRS adoption could be self-
defeating because the economies of scales and network effects will not be evident for such a small
group.
6.7. Create International U.S. GAAP (I-GAAP)
The prior scenarios present various combinations of IFRS and U.S. GAAP. To conclude, we
attempt to widen the accounting standards debate and offer another scenario that proposes a more
63 In fact, there is also the possibility that IFRS may never become mandatory for all firms in the U.S., raising the issue
of what “early IFRS adopters” are required to provide in the future. Even if they were allowed to continue to report
under IFRS, this outcome may impose future costs on “early IFRS adopters” because they would be outliers in a U.S.
market where the majority of other firms presumably still use U.S. GAAP.
92
proactive U.S. strategy to influence the direction of global financial reporting. In this scenario, the
U.S. would help create a newly revised set of accounting standards, “International U.S GAAP” (I-
GAAP), which can be adopted by other countries and, as such, competes with IFRS. We realize that
there are few large countries left that have not committed to IFRS and that it would be difficult and
costly for IFRS countries to switch to a yet another new set of accounting standards in the near term.
However, we discuss the “I-GAAP” scenario primarily as a thought experiment to illustrate an
interesting range of issues with IFRS and global accounting convergence.
First, a “one-size fits all” and truly global set of IFRS may (in the long-run) not meet the capital-
market needs of the U.S. and other “outside investor” economies with similar capital markets and
institutions (see Sections 4.1 and Section 5.2). Therefore, the U.S. could take the lead to develop a
competing set of standards to meet the specific requirements of capital market-oriented economies.
As U.S. GAAP would serve as basis for I-GAAP, they would have many features that are proven to
be compatible with “outside investor” economies and compatible with U.S.-style institutions.
Second, in the past, many international companies voluntarily prepared their financial statements
in accordance with U.S. GAAP. Thus, these companies viewed U.S. GAAP as a viable alternative to
IFRS. However, foreign governments and regulators were reluctant to officially adopt U.S. GAAP as
they have little direct influence and there is no formal representation on the FASB. In contrast, the
IASB allows national regulators and constituencies to have a say in the formulation of IFRS (see
Section 5.2). An “I-GAAP” scenario could address this problem by (i) avoiding the perception or
reality of being a set of “U.S.-only” standards, (ii) creating accounting standards in consultation with
other I-GAAP member countries, and (iii) opening up a reformulated FASB (an “I-FASB”) to
include representatives from other member countries.
93
Third, a critique of IFRS is that any country can adopt this set of high-quality standards
regardless of their ability to properly implement and enforce them. As a consequence, the standards
lose their ability to signal a country’s quality of financial reporting (Ball, 2006). I-GAAP could
overcome this problem and achieve credible high-quality reporting by admitting only countries that
meet certain strict requirements with respect to the implementation, enforcement and auditing of
financial reporting.
Fourth, the IASB includes representation from stakeholders around the world. A concern about
the IASB is that, over time as other countries grow in importance, the influence of the U.S. and hence
its say on the form of future IFRS would diminish (see Section 5.2). In contrast, I-GAAP and the I-
FASB could be comprised of countries that have similar policy goals to those of the U.S.
Fifth, if the U.S. retains U.S. GAAP, it may become isolated from other countries in its
accounting practices. Under the “I-GAAP” scenario, a broader set of countries could use the same
set of accounting standards as the U.S., increasing potential network benefits. Moreover, because I-
GAAP member countries also commit to certain implementation, enforcement and auditing
requirements, the comparability of reporting practices among I-GAAP firms is further reinforced.
Finally, there are a number of potential limitations of the “I-GAAP” scenario. It can impede
global convergence to a single set of accounting standards. Moreover, it might (i) encourage
localized accounting cartels, (ii) reinforce regionalized financial markets, (iii) increase trade and
investment barriers between regions, and (iv) could be perceived as giving the U.S. undue influence
relative to other member countries. Nonetheless, we believe that the pros and cons of this scenario
highlight important issues regarding the future of global accounting convergence.
94
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Adopting International Financial Reporting Standards for Use in the United States:
An Economic and Public Policy Perspective
James L. Bothwell Founder and President
Financial Market Strategies LLC January 23, 2009
The Financial Accounting Standards Board commissioned this study in September 2008. The analysis, conclusions, and opinions contained in this paper are strictly those of the author, who is solely responsible for any errors or omissions.
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Executive Summary
The United States Securities and Exchange Commission is proposing a potentially momentous action: Allowing certain U.S. public companies to prepare and file their 2009 financial statements in accordance with international financial reporting standards (IFRS) as issued by the International Accounting Standards Board (IASB) and possibly adopting and mandating the use of IFRS, rather than U. S. generally accepted accounting principles (USGAAP), for all U.S. public companies as soon as 2011.
This paper analyzes the potential economic and public policy implications of (1) adopting IFRS, or a similar set of international standards, to replace USGAAP, and (2) recognizing the IASB, or a similar body, as the official standard setter for U.S. public companies.
Among the major economic findings and conclusions:
• Adopting IFRS is highly unlikely to have any major, measurable macroeconomic impacts, either positive or negative, on the United States.
• Adopting IFRS could, at the margin, attract additional cross border investment and more cross listing of public companies, but such decisions are primarily based on factors other than accounting standards. No compelling empirical evidence exists as to how IFRS adoption could affect the cost of capital for U.S. firms.
• Adopting IFRS is unlikely to have a major impact on U.S. investors in the aggregate. Investors in certain U.S. industries could experience some loss in information content and quality. No compelling empirical evidence exists as to whether, or how much, U.S. investors could benefit from improved information.
• Adopting IFRS is likely to impose substantial transition costs on U.S. issuers of financial statements, and smaller firms are likely to disproportionately bear the costs of adoption. Adoption could also heighten issuers’ litigation risks, particularly for companies with more complex transactions. No empirical assessments of these costs and risks appear to exist in the literature.
• Adopting IFRS could have significant effects on tax receipts and U.S. financial institutions’ reported results and compliance with regulatory capital requirements.
Among the major public policy findings and recommendations:
• Existing material differences between IFRS and USGAAP should be addressed and reconciled before use of IFRS is permitted, even on a trial or option basis.
• A comprehensive analysis of the costs and benefits of IFRS adoption should be undertaken, and certain improvements in IASB’s operations, structure and funding should be required to be made, before IFRS use is permitted.
• A government-wide effort should be undertaken to heighten awareness of IFRS possible adoption and to better understand its likely impacts on affected government agencies and operations, before IFRS use is permitted.
• Consideration should be given to establishing an international accounting setting body that appropriately balances independence, sovereignty and accountability.
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Introduction
On August 27, 2008, the United States Securities and Exchange Commission (SEC) voted to publish for public comment a proposed “Roadmap” that would establish a process, including the setting of milestones and a timetable, by which all U.S. publicly traded companies could eventually be required to prepare their financial statements in accordance with international financial reporting standards (IFRS) as issued by the International Accounting Standards Board (IASB), rather than with U.S. generally accepted accounting principles (USGAAP) as established by the Financial Accounting Standards Board (FASB).
On November 14, 2008, the SEC issued the proposed Roadmap for a 90-day comment period. The proposed rule includes seven milestones that could, if achieved, lead to the SEC mandating in 2011 the use of IFRS by U.S. issuers. One of the major milestones is an option that permits a certain limited number of qualifying U.S. issuers to begin early filing of IFRS financial statements for fiscal years ending on or after December 15, 2009. To assist the SEC in its decision to mandate the use of IFRS, the proposed rule also directs the SEC’s Office of the Chief Accountant to study and report on “the implications for investors and other market participants of the implementation of IFRS for U.S. issuers.” 1
The SEC’s proposed Roadmap is only the most recent in a long series of actions that advocate, support, or facilitate the adoption of IFRS for use in the United States.2 Other prior measures include the issuance of the SEC’s 2007 Concept Release on Allowing U.S. Issuers to Prepare Financial Statements in Accordance with IFRS; the SEC’s 2007 Proposing Release on Acceptance from Foreign Private Issuers of Financial Statements Prepared in Accordance with IFRS without Reconciliation to USGAAP, and its subsequent adoption; the 2002 Memorandum of Understanding (i.e. the ‘Norwalk Agreement”) in which the FASB and the IASB formalized a commitment to achieving convergence between IFRS and USGAAP, and their subsequent 2006 Memorandum of Understanding and on-going work on an extensive set of convergence projects; the SEC’s 2000 Concept Release on International Accounting Standards, and the SEC’s 1988 Policy Statement supporting the establishment of mutually acceptable international accounting standards.
The United States is the largest economy, with the largest and most liquid capital markets in the world. At year-end 2007, the two principal U. S. stock exchanges, the NYSE Group and the NASDAQ stock market, accounted for over 40 percent of the total equity
1 Roadmap For the Potential Use of Financial Statements Prepared in Accordance with International Financial Reporting Standards by U.S. Issuers, SEC (Nov. 14, 2008) p. 34.2 More than 100 countries currently require or permit IFRS reporting, with over 85 of these countries, including all European Union countries, requiring IFRS reporting for all domestic, publicly traded companies. Other countries, such as Canada, are in the process of adopting IFRS.
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market capitalization of the world’s 12 largest stock exchanges and over 50 percent of the total share trading volume on these exchanges.3 Consequently, the SEC’s proposed adoption of IFRS as issued by the IASB is a potentially momentous change that could have major economic and public policy implications; not surprisingly, there exists a substantial public record resulting from the SEC’s rulemaking efforts to date. 4 Much of this public record contains the arguments, assertions, and viewpoints presented by various interested parties – multinational corporations, major accounting firms, various affected professional associations and groups, investors, stock exchanges, and other self-interested parties. 5
This paper, based upon a review of the existing public record and a number of relevant published academic studies in the accounting literature, is intended to present a neutral and unbiased perspective on the potential economic and public policy implications of the United States (1) adopting IFRS, or a similar single set of high quality international accounting and financial reporting standards, to replace USGAAP and (2) designating the IASB, or a similar organization outside of the United States, to be the independent, private sector international body that establishes and maintains such a single set of global standards for U.S. issuers. This paper also provides some insights gained from a series of discussions with informed market participants, and officials representing various U.S. government agencies that could potentially be affected by, or involved with, the adoption of international accounting standards; some thoughts on how recent political and economic developments could conceivably impact the adoption of IFRS in the United States; and some recommendations intended to help U.S. policymakers make the informed decisions necessary for achieving an enlightened public policy outcome for U.S. investors, firms and capital markets.
Economic Implications
Adopting IFRS, or a similar set of global accounting standards, for use in the United States could conceivably have major potential impacts on the economy as a whole, on U.S. firms that issue debt or equity to the public (i.e. “U.S. issuers”) and the industries in which they operate, on U.S. investors and capital markets, on the level and timing of U.S. tax receipts, and on U.S. financial institutions and regulators at both the federal and state levels of government.
Potential U.S. Macroeconomic Effects
For several reasons, it appears highly unlikely that IFRS adoption, or the adoption of any similar quality, single set of internationally accepted accounting standards, will have any significant macroeconomic impacts on the U.S. economy, either positive or negative, or
3 See Table 1 and Table 2 in Appendix I.4 Several jurisdictional variations of IFRS exist throughout the world. The term IFRS is used in this paper to refer to IFRS as issued by the IASB, unless explicitly noted otherwise. 5 This public record is available at www.sec.gov.
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at least any measurable effects on U.S. national output, income, employment, the general price level, or U.S. economic growth.
First, IFRS and USGAAP share major conceptual and operational similarities, although IFRS is commonly considered and described as being a more “principles-based” set of standards with more limited application guidance, and USGAAP as being a more “rules-based” set of standards with specific, some times lengthy and complex, application guidance.6 Both sets of standards, for example, generally incorporate accrual and historical cost accounting principles, with fair market revaluations required for certain types of financial instruments, and, in the case of IFRS, permissible for certain intangible assets, property, plant and equipment. IFRS and USGAAP also have similar materiality and consistency requirements, and, although there are differences in presentation, both sets of standards require the preparation of balance sheets, income statements, statements of cash flows and changes in stockholder equity or all recognized income and expense, and accompanying footnotes.
Second, several academic accounting studies provide some evidence that IFRS are equivalent to USGAAP in terms of the quality of information provided, and both sets of standards are almost universally considered to be of “high quality” by accounting professionals, statement issuers, and other informed commentators; a not surprising result since both the IASB and the FASB develop their standards using similar, transparent, consultative, deliberative and informed due processes.7 One recent survey of financial executives from U.S. listed companies, for example, found that 88 percent of respondents considered USGAAP to be of “high or very high quality” and 84 percent considered IFRS to be of “high or very high quality”.8 And, of over 90 comment letters submitted to the SEC in response to the 2007 Concept Release, only one commentator objected to the adoption of IFRS on the basis of it being an “inferior accounting system” based on “very vague” principles that are subject to manipulation and inconsistent application. 9
6 Comparisons of the similarities and differences in USGAAP and IFRS are available from the “Big 4” accounting firms. See: Similarities and Differences: A Comparison of IFRS and USGAAP, PriceWaterhouseCoopers (October 2007); USGAAP vs. IFRS: The Basics, Ernst & Young (2008); IFRSs and USGAAP: A Pocket Comparison, Deloitte (March 2007); and IFRS Compared to USGAAP, KPMG (May 2008). 7 See “Could IFRS Replace USGAAP? A Comparison of Earnings Attributes and Informativeness in the US Market”, Gordon, Jorgensen and Linticum (April 12, 2008) and previous studies by Leuz (2003), Bartov, Goldberg and Kim (2005) and Daske (2006).8 See letter to the SEC from Buthe and Mattli, dated November 13, 2008 and “Assessing the IASB: Results of a Business Survey about International Financial Reporting Standards and IASB’s Operations, Accountability, and Responsiveness to Stakeholders” Tim Buthe and Walter Mattli (18 November 2008). 9 See letter to the SEC from Carl Olson, Chairman, Fund for Stockholders Rights (Nov. 2007).
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While the existing literature does not contain one explicit, universally-accepted set of criteria for what “high quality” accounting standards should entail, two commonly noted tenets are that accounting standards should (1) fairly and accurately present the true economic substance of transactions and (2) effectively limit or curtail issuers’ ability to engage in egregious “earnings management” or manipulation. While it is conceivable that a set of accounting standards not meeting these two criteria could depress a nation’s investment and capital formation to such an extent that it negatively affected the macro-economy, such a possibility appears too remote to consider for such widely accepted and well regarded accounting standards as IFRS and USGAAP, especially in an economy with an annual gross domestic product exceeding $14 trillion. Although IFRS has been criticized by some for potentially leading to easier earnings manipulation because of its less detailed and less rules-based nature, any such earnings manipulation would likely have minimal macroeconomic effects. Empirically, any such effects, even if they were to occur, are likely to be completely masked by variations in the principal determinates of U.S. aggregate demand and supply.
Third, possibly material differences that currently exist between IFRS and USGAAP are being eliminated, or substantially diminished, through an on going set of convergence projects being jointly conducted by the FASB and the IASB. These projects seek to develop common standards to replace existing FASB and IASB standards that are both considered to need improvement and to diminish or eliminate existing differences between other standards. Completed projects have already addressed accounting standards for business combinations, borrowing costs, and segment reporting. On-going or planned projects include accounting for leases, insurance contracts, joint ventures, financial instruments and income taxes, as well as revenue recognition and financial statement presentation. The two boards are also jointly developing a common conceptual framework for developing future common, principles-based accounting standards.10
Fourth, while several academic studies of the reconciliation disclosures made by foreign firms cross-listed on U.S. exchanges report some substantial differences between IFRS and USGAAP reported net income and shareholders’ equity, the results of these studies are not sufficiently robust to be generalized to the whole economy. Most of the studies are based on small sample sizes, time periods before the IASB and FASB initiated their joint convergence projects, or short two- or three-year time periods that are not sufficiently long to account adequately for differences in the timing of income and expense recognition that could occur between IFRS and USGAAP. Moreover, some of the more recent reconciliation studies suggest that the differences in reported net income and equity are diminishing in magnitude, possibly as a result of convergence in the two sets of accounting standards. 11
10 A current listing of these projects, their status, and estimated completion dates is available at www.fasb.org. 11 For a review of many of these studies, see the American Accounting Association’s Financial Reporting Policy Committee’s: Response to the SEC Release, “Acceptance from Foreign Private Issuers of Financial Statements Prepared in Accordance with IFRS without Reconciliation to USGAAP (2007) and the Council of Institutional Investors’:
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Potential Effects on U.S. Portfolio Investment
With the world’s largest open economy, the United States experiences significant portfolio investment by foreign residents, with annual foreign net purchases of long-term U.S. securities exceeding $1 trillion for each of the 3 years, 2005-2007. 12 At June 2007, foreign holdings represented over $3 trillion, or 11 percent, of the total outstanding value of U.S. equities and over $2.7 trillion, or 24 percent, of the total outstanding value of U.S. corporate long-term debt. And the magnitude of foreign investment in long-term U. S. corporate securities has increased dramatically since 2000, almost doubling in percentage terms.13
Much of the foreign portfolio investment in the United States is from countries, such as the United Kingdom, that already use IFRS, and from countries, such as Canada, that are in the process of adopting IFRS.14 While foreign investors, like investors everywhere, undoubtedly make investment decisions based primarily on such economic factors as expected return, risk, and portfolio composition and diversification, adopting IFRS for use in the United States could make U.S. issuers’ financial statements more familiar, comparable and understandable to some foreign investors, and, at the margin, could attract additional foreign portfolio investment.
In particular, some observers suggest that adopting IFRS could make U.S. portfolio or direct investment more attractive to foreign private equity and sovereign wealth funds, especially those located in Middle East oil exporting countries that are familiar with IFRS and have significant U.S. dollar surpluses. As one Middle East investment banker succinctly noted: “The GCC (Gulf Cooperation Council) investors universally use IFRS. USGAAP has been a source of problem for them for some time. The use of IFRS by U.S. firms would be viewed as a positive step. Whether that would result in additional investments or not is difficult to say, but it would certainly be viewed positively by GCC investors.” 15 On the other hand, one recent academic study concluded that adopting IFRS is unlikely to reduce investors’ tendency to underweight foreign stocks relative to domestic stocks in their portfolios.16
International Convergence of Accounting Standards: What Investors Need to Know (2007)12 Source: U. S. Treasury International Capital (TIC) reporting system. Long-term U.S. securities include U.S. corporate equities and bonds, and U.S. Treasury and government agency bonds and notes with original stated maturities in excess of 12 months. 13 See Table 3 in Appendix I.14 See Table 4 in Appendix I.15 Private email exchange between the author and the managing director of a Middle East investment firm (October 13, 2008). 16 See “Information Frictions and Investor Home Bias: A Perspective on the Effect of Global IFRS Adoption on the Extent of Equity Home Bias”, Beneish and Yohn (May 23, 2008).
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Potential Effects on U.S. Equity Capital Markets
Adopting IFRS, and the SEC’s recent decision to eliminate the USGAAP reconciliation requirement for foreign firms, could, at the margin, attract more foreign companies to cross list on U.S. exchanges. Over the period 2004-2007, foreign firms accounted for about 14-to 15 percent of the total firms listed on the three largest U.S. exchanges. On the New York Stock Exchange, the largest U.S. exchange, foreign firms accounted for 18-to 20 percent of the total firms listed and have declined somewhat in both numbers and percentages, particularly from 2006 to 2007. 17
The data also show that, in total, the three major U.S. exchanges have not suffered any significant or sustained declines in either the number of listed firms or their total market capitalization during the period 2004-2007, although there has been some decline in the number of domestic and foreign firms listed on the more technology weighted NASDAQ exchange. While the three major U.S. exchanges have declined over this period in both the percentage of firms listed on the world’s exchanges (from 15.2 percent in 2004 to 12.8 percent in 2007) and the percentage of total market capitalization (from 44.2 percent in 2004 to 32.3 percent in 2007), the data also suggest that much of this phenomenon is due to the rapid growth and development of stock exchanges in China, India, and other emerging market countries -- not to any reduced competitiveness of U.S. exchanges that might conceivably be attributed to the use of USGAAP. 18
Adopting IFRS could also entice more U.S. companies to cross list on foreign exchanges by eliminating the potential for any cost and duplication of effort in having to prepare or reconcile financial statements using both USGAAP and IFRS. While many major foreign markets currently accept USGAAP financial statements from U.S. companies without reconciliation to IFRS, a change in policy to require future reconciliations has been discussed in several countries, particularly if the United States had not waived its requirement for USGAAP reconciliations for foreign firms listed on U.S. exchanges. In any event, like investment decisions, the listing decisions of both U.S. and foreign firms are likely to be driven primarily by expected net economic benefits and costs and not by the use of one set of accounting standards or another. NYSE Euronext, the one exchange to comment on the SEC’s 2007 Concept Release, cited “a significant benefit” for some listed firms if allowed the option to report under IFRS, but provided no estimates of the magnitude of that benefit, the potential impact of IFRS adoption on firms’ listing decisions, or on the global cost of capital.19
Potential Effects on U.S. Investors
U.S. investors could be significantly affected by IFRS adoption, depending on how the quantity, quality and accessibility of financial information are impacted. The overall
17 See Table 5 in Appendix I.18 See Table 5, Table 6 and Table 7 in Appendix I.19 Letter to the SEC from Mary Yeager, Assistant Secretary, NYSE Euronext, dated November 16, 2007.
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effect on U.S. investors in the aggregate, however, is likely to be neither significantly positive nor negative for the same set of reasons that IFRS adoption is unlikely to have any substantial impact the U.S. economy as a whole. While several academic studies of IFRS adoption in Europe and elsewhere provide some evidence that investors may have benefited from improved information quality, other studies show mixed results or conclude that other factors, such as the strength of enforcement or the degree of auditor “client-orientation”, are more important than the set of accounting standards being used.20
In any case, most of these studies are not apropos of the United States to the degree that USGAAP represents a higher quality set of standards than the various national sets of standards that had preceded IFRS adoption in these countries. As already noted, some observers believe that USGAAP represents higher quality standards than IFRS because they incorporate more specific rules that are less subject to differing interpretation and application, and some existing evidence, while mixed, indicates that U.S. investors appear to prefer USGAAP.21
Unless USGAAP-IFRS convergence is achieved first, U.S. investors in particular industries - the insurance and the extractive industries are often cited - could lose significant information that is currently made available by industry-specific standards in USGAAP that have no counterpart in IFRS.22 Of particular relevance for individual U.S. investors is the potential loss of basic information about the holdings, financial highlights and operations of U.S. mutual funds that are enumerated among other serious concerns about IFRS adoption expressed by the Investment Company Institute (ICI).23
The SEC’s recently issued proposed rule addresses the concerns raised by the ICI by proposing that investment companies be excluded “because of the separate regulatory requirements that exist for those entities.”24 To minimize any other potential information
20 See, for example, “Effect of Principles-based versus Rules-based Standards and Auditor Type on Financial Managers’ Reporting Judgments”, Jamal and Tan (July 21, 2008) and “The Information Content of Stock Prices, Reporting Incentives and Accounting Standards: The International Evidence”, Wang and Yu (March 2008). 21 See the American Accounting Association’s Financial Reporting Policy Committee’s: Response to the SEC Release, “Acceptance from Foreign Private Issuers of Financial Statements Prepared in Accordance with IFRS without Reconciliation to USGAAP (2007).22 Among its other projects, the IASB is currently developing comprehensive standards for both the insurance and extractive industries. Moreover, it should be noted that IFRS 4, which covers insurance contracts, permits an insurer to change its existing accounting policies for insurance contracts “only if, as a result, its financial statements present information that is more relevant and no less reliable, or more reliable and no less relevant.” 23 See letter to the SEC from Gregory M. Smith, Director, Investment Company Institute, dated November 13, 2007.24 Roadmap For the Potential Use of Financial Statements Prepared in Accordance with International Financial Reporting Standards by U.S. Issuers, SEC (Nov. 14, 2008) p. 60.
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losses, the joint IASB/FASB convergence projects should give priority to reconciling any significant differences in information content and quality between the two sets of standards, and the completion of such projects should be important milestones to be achieved before IFRS is adopted for use in the United States, even on a trial or optional basis.
It is instructive in this regard that the U.S. investor organizations commenting on the SEC’s 2007 Concept Release, without exception, either opposed or raised concerns about the use of IFRS or the operations of the IASB, or expressed support for the development of a single set of high quality globally-accepted accounting standards only with a strong “convergence first” stipulation because of concerns about existing material information differences between USGAAP and IFRS.25
U.S. investors also hold large and significantly increasing investments in foreign securities, primarily in EU countries that adopted IFRS in 2005 and in countries that either use IFRS or are in the process of adopting IFRS.26 While much of this foreign portfolio investment by U.S. residents is made through mutual funds, exchange-traded funds, and insurance companies and other institutional investors who are likely to be knowledgeable about, and familiar with, both sets of accounting standards, adopting IFRS for use in the United States could eventually make cross-border financial comparisons easier, thus improving the investment decisions of some U.S. investors. Once again, however, there exists no conclusive, or even compelling or suggestive evidence, as to the size of this potential investor benefit.
Potential Effects on U.S. Issuers
The most significant potential economic effects of IFRS adoption in the United States are likely to be on U.S. issuers, and to vary significantly according to firm size and industry classification.
All U.S. issuers will, of course, bear the costs of converting their accounting systems to IFRS and retaining and educating their accounting staff and executives.27 While transitional, such costs are likely to be very large and to be borne disproportionately by smaller firms. Surprisingly, none of the comment letters on the SEC’s 2007 Concept Release provide any estimates of the expected magnitude or distribution of these costs,
25 See letters to the SEC from the Investors Technical Advisory Committee (November 2, 2007), the Council of Institutional Investors (November 9, 2007), Calpers (November 14, 2007), the International Corporate Governance Network (November 14, 2007), the Investment Company Institute (November 13, 2007) and the Fund for Stockholders Rights (November 2007). 26 See Table 8 and Table 9 in Appendix I.27 CFO.com cites a recent Grant Thornton survey reporting that only 19 percent of chief financial officers and controllers have experience preparing financial statements in accordance with IFRS.
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although conceivably such costs could rival the costs that U.S. firms incurred ensuring that their computer systems would not be affected by the year 2000 millennium change.
Larger U.S. firms can be expected to realize scale economies in making an IFRS transition, and large U.S. multinational corporations could also realize some offsetting cost savings from not having to report following two different sets of accounting standards.
Large U.S. multinational firms are also much more likely to benefit from easier access to foreign investors and foreign capital markets, thus possibly lowering their cost of capital – the most frequently cited benefit of IFRS adoption - while smaller U.S. issuers with no need or desire to access foreign capital are likely to realize few, if any, offsetting benefits.
U.S. issuers are also likely to be exposed to some increase in litigation risk resulting from IFRS’ more general standards allowing for broader interpretation in their application. Litigants could argue that the interpretation that was made and applied was not the correct one and violated a commercial business’ duties to its shareholders. Larger U.S. issuers with more complicated transactions are more likely to face higher litigation risk than smaller firms. The existing public record and literature, however, provides no assessment of the magnitude of this potential risk for U.S. issuers.
Any major existing differences between IFRS and USGAAP as applied to specific industries could result in significant “post-adoption” effects on U.S. issuers operating in those industries. The extent and magnitude of these effects, however, will depend largely upon whether and how such differences are addressed in the joint FASB/IASB convergence projects that may be completed before IFRS adoption occurs in the United States. In addition, IFRS not allowing “last-in first-out” inventory accounting, which is not the subject of any current convergence project, could have major tax effects for many U.S. firms across industries.
With regard to financial institutions, both USGAAP and IFRS require similar fair value reporting for certain financial instruments. Fair value reporting has recently come under much criticism in both the United States and Europe for allegedly contributing to, or exacerbating, the ongoing global financial crisis, and both the FASB and the IASB have reportedly been under substantial pressure to modify or suspend their respective fair value standards. In the United States, the SEC rejected requests to suspend the fair value rules, recommended to Congress that the rules be maintained, and suggested some improvements with respective to current accounting practices. In contrast, the IASB’s credibility as an independent accounting setting body was damaged when it reportedly succumbed to European political pressure in late October 2008 and significantly relaxed its fair value standard without using its due process, transparent procedures. 28
28 See “S.E.C. Elects to Keep Mark-to-Market Rules”, Associated Press (December 31, 2008) and “Accounting Standards Wilt Under Pressure”, Glenn Kessler, Washington Post (December 27, 2008).
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In addition to the application of fair value rules for financial instruments, IFRS adoption could also have potentially significant implications for on-balance sheet reporting of securitized assets and liabilities and the allowable netting of assets and liabilities under master netting agreements for financial derivatives. Some U.S. financial regulators have also expressed concerns that IFRS could substantially affect the setting of bank loan loss reserves.29 Given the current fragile state of financial markets and institutions, the implications of any such potentially significant differences in the two sets of accounting standards for U. S. financial institutions should be analyzed, understood and addressed in the ongoing convergence projects before IFRS is considered for adoption in the United States, even on a trial or optional basis.
Potential Effects on the U.S. Treasury Department & U.S. Financial Regulators
As noted earlier, unless eliminated or substantially reduced by the joint convergence projects, existing material differences between IFRS and USGAAP are likely to have significant impacts on the timing, and possibly the level, of tax receipts, with consequent impacts on the federal budget deficit. And since required minimum regulatory capital levels for U.S. financial institutions are keyed to USGAAP financial reporting, the possible adoption of IFRS in the United States also has particular relevance to U.S. financial regulators and markets that goes beyond the need to make conforming changes to financial reporting requirements.
Public Policy Implications
Adopting IFRS for use in the United States has obvious public policy implications for the SEC. Because of its likely major economic impacts on U.S. issuers and industries, and the widespread operational effects it will almost certainly have on government reporting and information systems and on legal, tax and other documents, IFRS adoption also raises potential policy implications for such agencies as the Department of the Treasury, the Federal Reserve System, other federal and state financial institution and market regulators, the Small Business Administration, and the Department of Commerce.
Despite the SEC’s longstanding consideration of IFRS adoption, however, none of these agencies provided comments on the SEC’s 2007 Concept Release, and the findings of any analyses that these agencies may have conducted, or opinions that they may have formed, about the potential impacts of IFRS adoption or the SEC’s proposed Roadmap remain outside of the public record. The Government Accountability Office (GAO) is the one federal agency that commented in support of convergence to a single set of global accounting standards for public companies. The GAO, however, did not provide any empirical evidence or analysis to support its position. 30
29 Private conversations with the author (September 2008). 30 See letter to the SEC from David M. Walker, Comptroller General of the United States, dated November 13, 2007.
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To heighten government-wide awareness and benefit from the knowledge and analytical insights that these other possibly impacted federal agencies could provide, the SEC could consider placing IFRS adoption as an agenda item for discussion by the President’s Working Group on Financial Markets, which is chaired by the Secretary of the Treasury and includes the chairs of the Federal Reserve Board of Governors and the Commodity Futures Trading Commission, as well as the SEC, or by the National Economic Council. Additionally, the U.S. Congress could hold hearings to elicit testimony from these agencies on the potential impacts of IFRS adoption or task the two major congressional support agencies, the GAO and the Congressional Budget Office, to conduct impact analyses.
Several organizations that did comment on the SEC’s 2007 Concept Release noted some important organizational and operational changes that should be made in the IASB before the SEC should consider recognizing it, rather than the FASB, as the accounting standard setting body. Such changes include establishing more stable and independent funding sources, augmenting its staff and analytical expertise, and increasing investor representation on its board. Such recommendations are intended to increase the IASB’s independence and effectiveness and the SEC should consider their implementation to be important milestones to be achieved before IFRS adoption in the United States.
Surprisingly few commentators opined about the future role of the FASB if the SEC were to recognize the IASB as the official standard setter, other than to suggest that it could possibly focus on research or education and outreach efforts. And none of the commentators raised a very serious issue that could make IASB recognition a complete nonstarter: The potential loss in sovereignty for the very country with the largest, most resilient economy, and the largest, most liquid and efficient capital markets in the world.
Like financial regulators and central banks, accounting standard setters should be independent bodies insulated from the vagaries of political pressures and the undue influence of special interests. However, such bodies should not be so totally insulated or protected as to become unaccountable to the public or to duly elected or appointed government officials. Neither should such organizations infringe upon, or unduly affect, the sovereignty of nations. There is an appropriate balance between independence, accountability, and sovereignty that needs to be crafted and maintained.
In the wake of the present global financial crisis, and the accompanying controversy over fair value accounting for financial instruments, it seems virtually inconceivable that the United States Congress would permit the SEC to designate an international body such as IASB to set accounting standards for U.S. issuers (1) without the FASB having a permanently established and prominent role in researching and developing such standards and (2) without either the SEC, or the FASB on its behalf, having either prior approval authority or veto power over proposed IASB standards. Having the ability to interpret, change or modify IFRS as applied to U.S. issuers after issuance, which is what the SEC is now proposing in its Roadmap, could lead to the much less desirable result of having multiple national versions of IFRS and offset the very benefits that having a single, globally recognized set of high quality accounting standards are intended to achieve.
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One possibility is to structure a truly international accounting standard setting body so that it includes the heads of the nationally recognized accounting standard setters for the EU, the U.S., Japan, China and any other country whose domestic equity market capitalization exceeds 10 percent – or some other established objective threshold - of the world’s total equity market capitalization. This international body could also include voting members representing investors, issuers, accountants and other related professionals, but each of the national representatives would also have either prior approval authority or veto power over proposed international accounting standards, and each would have permanent staff involved with the research and development of new or modified international standards.
A Recommended Course of Action
While not unprecedented, it is neither usual nor desirable for major public policy decisions to be made without some compelling empirical evidence as to their likely effects. The paucity of evidence and analysis about SEC’s proposed adoption of IFRS for use in the United States is striking. The relevant academic accounting literature is large, but the results are mixed, and not robust or apropos to the United States. No estimates of the largest alleged benefits – lower capital costs for U.S. issuers and improved information for U.S. investors – nor of the largest obvious costs -- the costs to modify existing accounting systems and the costs of conducting related training and education – appear to even exist.
Such information could be collected and analyzed through the design and use of two data collection instruments (DCIs). First, a stratified sample of U.S. issuers could be surveyed to collect information about the potential costs of converting existing accounting systems and conducting necessary training and education. Information could also be collected about (1) possible cost savings that might be realized from not having to prepare and file duplicate financial statements, or provide reconciliations, and (2) any expected impacts on issuers’ cost of capital or likelihood of raising more capital in foreign markets.
Second, surveys could be conducted of individual and institutional investors. Both U.S. and foreign investors could be asked about the likely impact of IFRS adoption on their respective investment decisions. One particular focus could be to determine the extent to which IFRS adoption could lead to increased U.S. investment by foreign private equity and sovereign wealth funds. A nationally recognized and well-regarded survey research organization should be used to design unbiased DCIs and conduct the surveys to achieve the response rates necessary for generating statistically meaningful, robust results.
Alternatively, or perhaps additionally, the U.S. Congress could request its research and support agencies to analyze the potential impacts of IFRS adoption. GAO has extensive expertise in the subject area and often designs and conducts DCIs to address such public policy issues. CBO also has extensive analytical abilities, but is more oriented toward analyzing potential budgetary impacts. Similarly, the Treasury Department’s Office of Tax Analysis could be asked to analyze the potential tax implications of IFRS adoption.
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As noted earlier, the SEC’s proposed rule directs the Office of the Chief Accountant, in consultation with the SEC’s other divisions and offices, to undertake a study and report on “the implications for investors and other market participants of the implementation of IFRS for U.S. insurers.” 31 While certainly useful, this study should be undertaken, finished, reviewed and considered before U.S. issuers, especially U.S. financial institutions, are allowed even the option of using IFRS for financial reporting. For once offered and accepted, such an option is likely to be extremely difficult to rescind and could lead to a prolonged period of dual financial reporting for U.S. issuers that could be confusing to U.S. investors.
Finally, the SEC should be encouraged to heighten government-wide awareness of its proposed adoption of IFRS in the United States, perhaps by raising it as an agenda item for the President’s Working Group or the National Economic Council, or by organizing and leading a joint government effort to share information, conduct impact analyses, and possibly coordinate preparations.
31 Roadmap For the Potential Use of Financial Statements Prepared in Accordance with International Financial Reporting Standards by U.S. Issuers, SEC (Nov. 14, 2008) p. 34.
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APPENDIX I
Table 1: Domestic Equity Market Capitalization of 12 Largest Stock Exchanges
Exchange Billions of U.S. Dollars at
December 2007 1. NYSE Group 15,651 2. Tokyo Stock Exchange Group 4,331 3. Euronext 4,223 4. Nasdaq Stock Market 4,014 5. London Stock Exchange 3,852 6. Shanghai Stock Exchange 3,694 7. Hong Kong Exchanges 2,654 8. TSX Group 2,187 9. Deutsche Borse 2,105 10. Bombay Stock Exchange 1,819 11. BME Spanish Exchanges 1,799 12. National Stock Exchange of India 1,660 Total 47,989
Source: World Federation of Exchanges, 2007 Annual Report and Statistics.
Table 2: Share Trading Value of 12 Largest Stock Exchanges
Exchange Billions of U.S. Dollars at
December 2007 1. NYSE Group 29,910 2. Nasdaq Stock Market 15,320 3. London Stock Exchange 10,333 4. Tokyo Stock Exchange Group 6,476 5. Euronext 5,640 6. Deutsche Borse 4,325 7. Shanghai Stock Exchange 4,070 8. BME Spanish Exchanges 2,970 9. Borsa Italiana 2,312
10. Hong Kong Exchanges 2,137 11. Shenzhen Stock Exchange 2,103 12. Korea Exchange 2,006 Total 87,602 Source: World Federation of Exchanges, 2007 Annual Report and Statistics.
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Table 3: Value of Foreign-Owned U.S. Long-term Securities and Share of the Total Outstanding
Type of Security
Dec 1994
Mar. 2000
June 2002
June 2003
June 2004
June 2005
June 2006
June 2007
Total U.S. long-term securities Total
outstanding 15,700 36,583 32,169 33,443 37,499 39,583 43,074 48,718
Foreign-owned
1,244 3,558 3,926 4,503 5,431 6,262 7,162 9,136
Percent foreign-owned
7.9 9.7 12.2 13.5 14.5 15.8 16.6 18.8
Corporate Equity Total
outstanding 7,767 24,703 17,904 17,941 20,779 22,041 23,760 27,768
Foreign-owned
398 1,709 1,395 1,564 1,930 2,144 2,430 3,130
Percent foreign-owned
5.1 6.9 7.8 8.7 9.3 9.7 10.2 11.3
Corporate Debt
Total outstanding
3,556 5,713 7,205 7,852 8,384 8,858 10,284 11,391
Foreign-owned
276 703 1,130 1,236 1,455 1,729 2,021 2,738
Percent foreign-owned
7.8 12.3 15.7 15.7 17.6 19.5 19.7 24.0
Billions of U.S. dollars. Source: Report on Foreign Portfolio Holdings of U.S. Securities, Department of the Treasury, Federal Reserve System (April 2008).
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Table 4: Value of Foreign Holdings of U.S. Securities by Major Investing Country and Type of Security
Country Corporate
Equity Corporate Long-Term
Debt United Kingdom 421 405 Canada 347 84 Cayman Islands 279 347 Luxembourg 235 340 Japan 220 119 Netherlands 185 84 Switzerland 174 89 Middle East Oil-Exporters 139 17 Ireland 81 136 China 29 28 Belgium 25 321 Country Unknown - 212 Rest of World 995 555 Total 3,130 2,737 Billions of U.S. dollars at June 30, 2007. Source: Foreign Portfolio Holdings of U.S. Securities, Department of the Treasury, Federal Reserve System (April 2008).
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Table 5: Number of Listed Companies on Major U.S. Exchanges
Exchange 2007 2006 2005 2004
NYSE - Total 2,297 2,280 2,270 2,293 NYSE - Domestic 1,876 1,829 1,818 1,834 NYSE - Foreign 421 451 452 459 Percentage Foreign 18.3 19.7 19.9 20.0
NASDAQ - Total 3,069 3,133 3,164 3,229 NASDAQ - Domestic 2,762 2,812 2,832 2,889 NASDAQ - Foreign 307 321 332 340 Percentage Foreign 10.0 10.2 10.5 10.5
AMEX - Total 599 592 595 575 AMEX - Domestic 495 492 495 502 AMEX - Foreign 104 100 100 73 Percentage Foreign 17.4 16.9 16.8 12.7
U.S. - Total 5,965 6,005 6,029 6,097 U.S. - Domestic 5,133 5,133 5,145 5,225 U.S. - Foreign 832 872 884 872 Percentage Foreign 13.9 14.5 14.7 14.3
WFE - Total 46,509 45,211 39,941 39,973 Percentage U.S. 12.8 13.2 15.1 15.2
Source: World Federation of Exchanges (WFE) Annual Reports and Statistics, 2005-2007.
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Table 6: Market Capitalization of Major U. S. Exchanges
Exchange 2007 2006 2005 2004
NYSE 15,651 15,421 13,632 12,707 NASDAQ 4,014 3,865 3,604 3,533
AMEX 258 283 201 83
U.S. - Total 19,665 19,569 17,437 16,324 WFE – Total 60,874 50,792 41,411 36,863
Percentage U.S. 32.3 38.5 42.1 44.2
Billions of U.S. dollars. Source: WFE Annual Reports and Statistics, 2005 – 2007.
Table 7: Five Most Rapidly Growing Exchanges
2007/2006 2006/2005 2005/2004
Shanghai SE 303% Shanghai SE 221% Cairo/Alex SE 106% Shenzhen SE 244% Cyprus SE 146% Columbia SE 100% Bombay SE 122% Mauritius SE 113% Korea SE 84% India National SE 115% Shenzhen SE 97% Sao Paulo SE 44% Luxemburg SE 109% Ljubljana SE 92% India National SE 42%
Annual percentage change in year-end market capitalization in U.S. dollars. Source: WFE Annual Reports and Statistics, 2005 – 2007.
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Table 8: Market Value of U.S. Holdings of Foreign Securities by Type of Security
Type of Security Dec. 2001
Dec. 2003
Dec. 2004
Dec. 2005
Dec. 2006
Long-Term Securities: 2,170 2,954 3,553 4,346 5,623 Equity 1,613 2,079 2,560 3,318 4,329
Long-Term Debt 557 874 993 1,028 1,294 Short-Term Debt 147 199 233 263 368 Total 2,317 3,152 3,787 4,609 5,991 Billions of U.S. dollars. Source: U.S. Portfolio Holdings of Foreign Securities, Department of the Treasury, Federal Reserve System (November 2007).
Table 9: Market Value of U.S. Holdings of Foreign Securities by Country and Type of Security
Country Total Equity Debt United Kingdom 1,076 674 401 Japan 596 544 53 Canada 478 298 180 France 401 307 95 Cayman Islands 376 161 215 Germany 292 220 72 Switzerland 264 263 1 Netherlands 234 161 73 Bermuda 208 192 17 Australia 173 102 72 South Korea 124 114 10 Ireland 121 48 72 Rest of World 1,647 1,245 401 Total 5,991 4,329 1,662 Billions of U.S. dollars as of December 31, 2006. Source: U.S. Portfolio Holdings of Foreign Securities, Department of the Treasury, Federal Reserve System (November 2007).
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